Can Recession be a Fruitful Event?

1 Jul 2022  Read 1091 Views

During the financial crisis of 2008, the US economy fell by 4%, and the unemployment rate was close to 10% until 2009. People lost their lives due to unemployment. During the crisis, the US stock market almost fell by almost 50%. People lost their life savings, and the condition was so bad that they lost their homes too.

The housing bubble burst and the prices of houses collapsed by 30%. The poverty rate in the United States increased from 12.5% in 2007 to more than 15% in 2010. American households lost an estimated $16 trillion in net worth. The GDP of India fell from 9% to 7.8% in 2008. Approximately $12 billion worth of investors withdrew from the stock markets, and a huge fall was witnessed.

And this was a single recession. The National Bureau of Economic Research (NBER) has identified 32 recessions since the mid-1850s in the US itself.

But there is an adage: "Everything happens for the greater good." So, the recession might have some 'good' in it, right? 

What's a recession?

As per the definition, a recession can be confirmed when the GDP of an economy undergoes negative growth for a minimum of 2 quarters. But this definition has a few criticisms as well.

Many economists believe that one could identify that an economy is in recession by analyzing the decrease in manufacturing output levels and the unemployment in the sector. The NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales”.

Most recessions since 1945 lasted an average of 11 months, but their impact has been long-lasting. 

Outcomes of a recession

A recession slows down the economy of a country. The economy declines and stagnates for a long time. When an economy undergoes a recession, customer spending and consumption is the first brick that falls. 

Manufacturing jobs can generally foresee a recession coming. This is due to the advance orders by customers. A recession affects consumer behaviour as well. Retail sales start to fall, demand for automobiles declines, money flow in the economy slows down, and unemployment rises. Crimes, drug consumption, alcoholism and violence increase during unemployment.

As spending decreases, so does the demand for products. This leads to companies cutting off their production output and laying off their workforce. When real income declines, so do consumer purchases and demand. Of course, the real income is related to the employment rate, and real income displays the state of the overall economic health.

The government starts capital infusion and starts to bail out the economy with stimulus packages. Banks and other companies are provided with capital by the government. The government also starts to influence the demand in the economy by changing the interest rates.

Due to the recession, the government fails to receive more revenue from taxes, fees, investments etc. Job openings are increased by the government to increase employment and rejuvenate the economy. 

Income inequality increases among the population. The rich get richer, and the poor get poorer. The number of millionaires created during the covid crisis is obvious proof of this concept. 

Major global recessions

Did you know that during the 2008 financial crisis, the World GDP fell by 1%? 

1. The Great Depression of 1929-39 was triggered by the stock market collapse, poor banking system, The Smoot-Hawley Tariff Act (1930) and gold standards. During this period, the world GDP fell by 15%. Unemployment was hovering near 20%.

By early 1933, almost 13 million were out of work, and the unemployment rate stood at an astonishing 25%. This was the most severe and longest recession in human history.

2. The global recession of 1975 was caused due to the surge in world oil prices from the Arab oil embargo initiated in October 1973. Although the embargo ended in March 1974, the aftermath increased inflation.

During this period, the USA lost the war in Vietnam. Also, the Bretton Woods system was curtailed. The U.S. Bureau of Labor Statistics estimates that 2.3 million jobs were lost during the recession; at the time, this was a post-war record. The recession lasted for 2 years, and the US GDP contracted by 3%.

3. The global recession of 1991 was triggered by the Gulf War. Due to severe uncertainty in geopolitics, oil prices rose quickly. As oil prices increase, so does inflation. This again led to the Fed hiking the interest rates.

The recession was also fueled by the old hiked rates during the mid-1980s. Japan was also facing a long recession in its economy. The USSR disintegrated into Russia. The recession lasted for 8 months.

4. The dot-com recession of 2001 was caused due to the dot-com bubble burst. Sadly, in September 2001, the US saw the deadliest attack on the country. This created a sharp fall in the demand in the economy. The recession lasted for eight months.

5. The subprime crisis of 2008 was a global phenomenon. It was caused by the fall in housing prices as a result of the collapse of the housing bubble.

As a result of the housing bubble's collapse, borrowings for acquiring housing properties faced defaults, which led to foreclosures. Following this crisis came the Great Recession, which exacerbated homeowners' problems who had purchased properties during the boom period. The same homeowners were now unable to make mortgage payments.

You can read about it thoroughly in The Financial Crisis of 2008 blog.

The positives of a recession 

Every economy has bounced back from a recession with robust growth and returns. In 2008, after the Lehman Brothers collapse, the stock market fell by almost 50%. Within 2 years, the stock market doubled. When the dot-com bubble burst, the NASDAQ fell by 80% and within 2 years the stock market gave 100% returns i.e doubled. In the long term, the stock market has always travelled in an uptrend.

This is because when an economy performs well, business performance improves and so do the stocks of these companies. These are small speed bumps in the journey and one must use these dips to accumulate more stocks.

During a recession, the prices and demand for commodities start falling. For instance, petrol prices tend to fall during the recession. This creates an opportunity for developing nations to purchase more oil and gas.

India roughly imports 85% of its crude oil consumption and as the prices of fuel start to fall, it becomes cheap for India. This reduces the county’s import bill, thus decreasing the current deficit. As oil is the basic commodity for the majority of industries, cheaper oil also reduces inflation. Housing prices, interest and loan rates cool off as well. 

A paradigm shift takes place in the economy after a recession as the over-hyped companies with weak business structures collapse and the ones with a competitive advantage or moat thrive. During economic booms, a lot of startups and companies go public. They desire to list on the stock markets as the promoters can easily unload their shares at a premium.

During a recession, these companies fail to list on the markets with a premium. The stock prices start to plummet from the day they get listed. Only companies which are recession-proof are the ones which survive. 

Recessions teach multiple life lessons. It teaches one to maintain savings for the future and worse conditions. It teaches about the importance of family and life, resilience, patience and more. 

The Bottom Line 

A recession could be a boon or bane; but what really matters is resilience, adequate preparation and the right mindset. Savvy investors wait for these once-in-a-lifetime opportunities to make money while amateur investors lose money.

Warren Buffett says "I don't pay any attention to what economists say, frankly." Many famous investors believe that macro events should not hinder your business analysis. There is a macro event buzzing around in the economy every year. Great investors believe macro events are only distractions. As an investor, one should analyze a business and its moats. If economists could predict a recession and economic booms, they would have been the richest people on the planet.

About the Author: Akshat Yadav | 8 Post(s)

Akshat is a finance enthusiast. Loves to read and write about it. Being passionate about investing, he believes any layman could excel in this subject. From companies and industries to individual stocks, he shares his thoughts on finance, stocks, and investing.

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