What happens in a recession?

What is a recession?

From a technical standpoint, a recession is often defined as two consecutive quarters of shrinking gross domestic product (GDP). But more simply, it’s a sustained contraction in economic activity. Dwindling production and consumption, as well as higher unemployment or lower prices are tell-tale signs the economy has made its way into recession territory.

The Business Cycle Council of the C.D. Howe Institute, one of Canada’s most influential think tanks, is generally recognized as the authority in Canada when it comes to declaring a recession. They call a recession “a pronounced, persistent, and pervasive decline in aggregate economic activity” and regard GDP contraction and unemployment as two of the most defining metrics. 

When were the most recent recessions in Canada?

Canada’s most recent recession dates back to the early days of the COVID-19 crisis. According to the C.D. Howe Institute, a recession began in March 2020 and ended in April 2020, making it the shortest (but also the deepest) recession

Front and center in the years leading up to the COVID-19 pandemic was the Great Recession, which began at the tail end of 2008 and continued until May 2009. Real GDP fell roughly 4.3% from its pre-crisis level to its recessionary trough, and unemployment peaked at 8.1% during 2009 (up from 4.5% at the start of the crisis).¹  While similar developments unfolded in the U.S., unemployment didn’t peak until October 2009, suggesting the end of a recession doesn’t necessarily signal the end of economic distress.²

Shorter yet milder recessions in Canada were fueled by the bursting of the dot-com bubble in 2001, the first Gulf War in 1990–1991, and central bankers’ attempts to rein in inflation in 1981–1982.

What causes recessions?

Recessions generally stem from waning confidence, a sense among businesses and consumers that the economic tide is shifting. But from a broader view, recessions are often the result of structural changes in one or more key industries, economic shocks, or even psychological forces such as extreme optimism (which can lead to speculative behaviour). Financial bubbles bursting (such as the stock market crash of 1929 or the real estate crash of 2007) can also be the cause of recessions. Recessions can also be induced by central banks; as they try to lower inflation by raising interest rates, they may inadvertently (or sometimes even knowingly) cause a recession.

What happens in recessions?

• Unemployment often rises—Unemployment typically rises as businesses cut back or shut down, but the degree of disruption can vary. The unemployment rate reached as high as 10.3%³ in Canada during the relatively mild recession of 1990–91, yet it continued to increase after the recession was declared over.
• People may save more—People who still have their jobs tend to spend less in recessions, worrying that they may become unemployed, while those that are already unemployed naturally cut back on spending. As more people reduce their spending, the result can be a negative economic spiral (since consumer spending makes up a large part of the economy) leading to progressively lower incomes, higher unemployment, and an extension or deepening of a recession.
• Manufacturing and services can decline—The Canada Ivey Purchasing Managers Index, which surveys senior executives in a wide variety of industries in Canada, showed more than 130 consecutive months of manufacturing growth from the spring of 2009, when the Great Recession ended, to today.
• Prices can fall—Severe recessions can lead to deflation—a general decrease in prices— especially of discretionary items and real estate. In this environment, spending focuses on relatively low-priced necessities.
• Liquidity can dry up—Banks become less motivated to lend in recessions for fear of not being repaid, so it may be harder to take out a loan. Interest rates also tend to fall, shrinking banks’ profit margins.
• Deficits can increase—Governments often increase spending to offset the recession’s effects. At the same time, tax receipts fall as corporate and personal incomes decline.

How should you invest during a recession?

Just like good economic times, investing during a recession really comes down to being properly diversified. By investing across various asset classes, geographic regions, and management styles, an investor can take part in up markets and avoid the whims of panic selling in down markets.

Unfortunately, there are no recession-proof asset classes. Nonetheless, it’s worth exploring how two of the most central components of investor portfolios tend to respond in this environment:

• Bonds—Investors often turn to bonds to help cushion the impact of stock market downturns. While they’re a far cry from being risk-free investments, bonds offer a steady stream of interest income and are generally viewed as safer investment alternatives in times of uncertainty.
• Stocks—Stocks often pull back ahead of recessions, but by the time the recession actually happens, it’s usually too late. Since recession concerns are usually baked into stock prices, it’s harder to use them as a reference point for predicting a recession. In fact, not only are falling markets poor predictors of recessions (the 1987 crash didn’t lead to one), but recessions don’t necessarily imply stock market declines either.

Is a recession coming?

There’s no real answer to that question, as predicting the next recession is anything but an exact science. Due to the nature of economic indicators, the beginning of a recession can only be confirmed after it has actually started, so it’s entirely possible for an economy to be in a recession without investors even knowing it.

What is certain, however, is that a healthy economy regularly transitions from expansionary to contractionary phases and back again. Navigating through these cycles can be unsettling but it’s important to stay focused on a long-term end goal and remember that recessions come and go. Revisiting your investment strategy in this context is vital but keeping your emotions in check is equally important.

1 Statistics Canada. 2 Federal Reserve Bank of St. Louis 3 Statistics Canada