Is the stock market a good signal that a recession is coming?

Stock prices look ahead and sometimes fall before a downturn, though they also fall at times when no recession follows, and they can rise while the economy is still weak. The market is one input among many, and a decline on its own does not tell you a recession has begun or will begin.

How long does a typical recession last?

There is no set length. By the dating committee's description a recession lasts more than a few months, and the committee dates it from the peak of activity to the trough. Some have been short and sharp, others long and shallow, and nobody can say in advance which kind is underway.

What Is a Recession, and Who Decides When One Starts?

Q: What Is a Recession, and Who Decides When One Starts?

In the US, the Business Cycle Dating Committee of the National Bureau of Economic Research dates recessions. It describes one as a significant decline in economic activity spread across the economy and lasting more than a few months, and it announces the dates after the fact, often many months later.

Two quarters in a row of shrinking GDP gets called a recession on financial television almost every time it happens. It is a handy rule of thumb. It is also not how the United States officially decides.

Who actually decides?

A private, nonprofit research organization, the National Bureau of Economic Research. Within it, a small group of economists called the Business Cycle Dating Committee identifies the turning points in the economy: the peak, where activity tops out, and the trough, where it bottoms. The stretch between a peak and the following trough is the recession.

The committee’s own description is a significant decline in economic activity that is spread across the economy and lasts more than a few months. Put another way, it weighs how deep the fall is, how widely it reaches across industries and regions, and how long it lasts. A very deep but brief fall can qualify. So can a long, broad one that is shallower.

No statute gives the committee this job. Its dates are simply the ones economists, the government and the press have come to accept.

What does the committee look at?

GDP is one input. The committee also looks at monthly measures, since quarterly GDP is too coarse to pin down the month a turn happened: employment, real personal income excluding government transfer payments, real consumer spending, industrial production and inflation-adjusted sales at manufacturers, wholesalers and retailers. When those measures fall together and keep falling, the case builds.

That is also why the two-quarter rule can miss. GDP can dip for two quarters while employment and income hold up, or a broad decline can be severe enough to count while one of the quarters still shows a small gain. The rule of thumb is a quick screen. The committee’s judgment is the official record.

Take a hypothetical economy where output slips a fraction of a percent in each of two quarters, mostly because companies ran down their inventories, while employers keep adding workers and household spending keeps rising. The rule of thumb calls that a recession. A committee looking for a decline spread across the economy might well not. Headlines and the official record can disagree for months.

Why does the announcement come so late?

The data arrive slowly and get revised. Early GDP and employment figures are estimates, later corrected as fuller information comes in, and the committee waits until the revised picture is clear enough that it will not need to change its call. Deciding that a peak has passed means being confident that the decline that followed was deep and broad enough, and that takes months of data after the turn itself.

So the announcement that a recession began is often made many months after it began. Sometimes the recession is already over by the time the start date is published. The end date comes later still.

Run the timeline for a hypothetical downturn. Activity peaks in month one. Payrolls start shrinking a couple of months later, share prices drop hard on the weak reports and the earnings warnings that follow, and the committee, having waited for the revisions to settle, announces around month twelve that the recession began back in month one, a date nearly a year old by the time anyone reads it. Every trade that mattered happened in between.

What does that mean for your account?

The label is useless for timing trades. Prices react to the data long before the verdict.

What you can use is the committee’s raw material, as it comes out. Monthly payrolls, income, spending and industrial output all appear on the economic calendar. Earnings releases add what companies see in their own orders. None of these will tell you a recession has started, but together they show which way activity is moving.

A few habits help:

Treat “recession” headlines as a description of the past. Ask what the latest monthly figures say instead.
Watch revisions. A strong first estimate that gets revised down is often more informative than the first estimate itself.
If you hold positions on margin, a weakening economy is a reason to check how far your holdings could fall before a call, whether or not anyone has used the word yet. Crowd borrowing figures are covered in the column on margin debt data.

The central bank and the government both respond to downturns, with different tools and on different timetables, as laid out in monetary vs fiscal policy. A weak economy with high inflation is its own problem, described under stagflation. More on reading the economy for your account sits in the economics section.