- What is a recession?
- Types of recessions
- What happens during a recession?
- What causes a recession?
- What are the signs a recession is coming?
- Industries that suffer the most during a recession
- Which industries are best able to weather a recession?
- How long do recessions last?
- Recessions in Canada since 1970
- How does a recession affect new and young investors
- How to prepare for a recession
- Recession vs. depression
- Bear market vs. recession
- Frequently asked questions about recessions
You may have seen headlines or posts in your social media feeds warning that the economic signs of a looming recession. But what is a recession, anyway? And is it really something you have to worry about as an investor? Here’s what you need to know about this type of economic downturn, including what happens during a recession, how long it typically lasts, what causes a recession and how economists determine when we’re in a recession vs. depression.
What is a recession?
At its most basic, a recession is a sustained period — usually at least six months — when a country’s economic activity declines. More specifically, a recession is often defined as two consecutive quarters in which the national Gross Domestic Product (GDP), the most common measure of a country’s economic growth, decreases.
Types of recessions
Recessions tend to follow different patterns, which are evident once the economy recovers. For example:
- V-shaped recessions have a sudden sharp decline, quickly followed by a strong rebound or recovery.
- U-shaped recessions last longer than V-shaped ones, with the economic trough bumping along the bottom for a while, then gradually coming back up.
- W-shaped recessions, which are also known as “double-dip” recessions, experience a second decline in economic activity soon after a recovery from the initial plunge.
- L-shaped recessions have a stomach-churning drop followed by very slow growth for an extended period, with no timely recovery to previous economic output. This is most often called a “depression.”
What happens during a recession?
As mentioned, economic activity declines during a recession. There are distinct ways you’ll see this play out, which include the following:
- Business output decreases: With revenues and profits shrinking, companies look for ways to reduce costs, including lowering production.
- Higher unemployment: Another way businesses can cut expenses when they have less money coming in is by reducing staff hours or imposing layoffs, so unemployment rises.
- Stagnating or falling wages: When unemployment is high, workers have less bargaining power to negotiate raises.
- Consumer spending slows: When workers have less money to spend (or are worried that they could be next to lose their jobs) they reduce their spending accordingly.
- Stock markets decline: As publicly listed businesses reduce their output — and profits fall — their stock prices go down.
What causes a recession?
There are many factors that can lead to an economic recession. Here are the some of the main causes:
- Economic shock: Any sudden unexpected event that plays havoc with the economy, such as war or a pandemic, can impact the way people and businesses spend and save. If there’s a decrease in spending and growth falls, the economy could find itself in a recession.
- Debt: When too many businesses and consumers have too much debt, they may default on their loans and declare bankruptcy, which can upend the economy. An example is the U.S. subprime mortgage crisis of 2008, where rapid mortgage rate increases on subprime loans made it difficult for people to make payments on their homes.
- Hyperinflation: Most central banks have a target range for inflation, typically about 2%. Hyperinflation occurs when the cost of living rapidly surges above that range. When that happens, it can cause consumers to cut back on their discretionary spending to make ends meet. A rapid decrease in consumer demand can, in turn, affect businesses’ bottom lines and lead to a recession.
- High-interest rates: In an attempt to combat hyperinflation, central banks often raise interest rates. But when the cost of borrowing goes up, it can make it harder for overleveraged businesses and consumers to pay down debt and discourage investment and consumer spending.
- Deflation: Economies react poorly when prices decline. Deflation hurts business profits, which may lead companies to lay off workers or lower staff wages.
- Asset bubbles: Occasionally, investors overvalue a market or sector, which can lead to an asset bubble. When the bubble bursts, you might see layoffs in the sector, and lower consumer spending. If the industry is a big contributor to the economy, a decline in revenues from that sector could impact a country’s overall economic growth.
- Loss of consumer confidence: When consumers are unsure what will happen with jobs, incomes, prices or interest rates, they may cut back on spending to save more for a potential rainy day. That decline in consumer spending can kick off a recession.
What are the signs a recession is coming?
You can never know for sure when a recession might be on its way, but economists and other experts have looked at previous downturns and identified some recurring signs that may help indicate when a recession is on the horizon:
- Unemployment hits rock bottom. Research shows that, historically, the unemployment rate reaches a low several months (nine months, on average) before the onset of a recession. Of course, it’s difficult to know when the rate has really bottomed out unless enough time has passed to indicate that any increase in unemployment isn’t just a temporary fluctuation.
- Incomes rapidly increase. This indicator is often tied to low unemployment since businesses may have to pay higher wages to retain and hire staff when qualified candidates are scarce. Those increasing wages, however, are a big expense to businesses and can be a harbinger of a coming recession.
- The housing market cools. A large portion of Canadian economic activity is tied to the housing market. As such, a drop in new housing construction and home sales can be a sign of a recession to come.
- Economic indicators are weak. Every month the Conference Board of Canada tracks the performance of nine economic indicators — things like building permits, manufacturing orders, stock prices, consumer expectations and unemployment claims — through the Composite Index of Leading Indicators, also known as the Leading Economic Index. When the score goes south, there’s a greater possibility of a recession.
- The bond yield curve flips. In simplest terms, the yield is the return on capital you will earn from a bond if you hold it to maturity. The yields on short-term government bonds are usually lower than those on long-term ones. Occasionally, however, the yields reverse, with higher yields on short-term bonds versus long-term ones. This so-called inverted yield curve often precedes a recession.
- There’s a sustained bear market. When stock prices decline by 20% or more, it’s called a bear market. Historically, the longer a bear market lasts, the more likely it is that a recession is on its way. Many younger investors have limited experience with bear markets, if any. Here’s a look at what bear markets have looked like in the past.
Industries that suffer the most during a recession
When consumers and businesses have less money to spend, there are some things they are more likely to cut back on than others. As a result, some industries may get hit harder by a recession, including the following:
- Hospitality: Leisure trips and business travel can be low-hanging fruit when it comes to budget cuts, which can have knock-on effects on hotels, restaurants and travel companies.
- Printing and publishing: Businesses may have reduced needs for printing internal and sales material when their output is reduced, and consumers may cut back on the number of periodicals or books they purchase to save money. During past recessions, advertising revenue for newspapers and publishers has contracted.
- Construction, lumber and concrete: Developers are less likely to build during a recession and owners are less likely to renovate.
- Non-essential retail and services: Any product or service that a business or consumer can temporarily do without.
Which industries are best able to weather a recession?
Some industries are more recession-proof by nature because they are regarded as necessities. In other words, no matter how much prices rise, Canadians will likely still have to spend money at roughly the same rate as they have in the past. These industries include:
- Transportation (though auto sales can fluctuate depending on how much people are spending)
How long do recessions last?
The C.D. Howe Institute’s Business Cycle Council is Canada’s main arbiter of business cycle dates. It has in the past announced the official start and end dates of recessions to the Canadian economy after it has observed a sustained recovery and can pinpoint when the economy bottomed out. Of the five recessions that have taken place in Canada since 1970, the average length is about nine months, but they have varied from as little as two months to more than two years, as shown below.
Recessions in Canada since 1970
- The COVID-19 Recession (February–April 2020)
- The Great Recession (October 2008–May 2009)
- The Gulf War Recession (March 1990–May 1992)
- The Stagflation Recession (June 1981–October 1982)
- The Oil Shock Recession (October 1974–March 1975)
How does a recession affect new and young investors
If you’re new to investing, the economic upheaval of a recession may seem scary. But it’s important to remember that recessions are normal aspects of the economic cycle and should be expected from time to time. That’s why it’s so important to understand your time horizon and financial goals when investing.
For example, if you’re young and investing for retirement, your long-term horizon can help you weather any ups and downs in the economy and markets. The key is to look at your average return on investment over many years, not only during any one limited period. By staying invested, you’ll not only avoid locking in any losses resulting from selling during a down market, but you’ll also be sure to enjoy the growth that comes with the eventual market recovery.
How to prepare for a recession
You never know when adversity may strike, but these tips can help protect you from the perils of a financial setback.
- Build a budget. It’s hard to come up with a plan to save money if you’re not sure what amounts you have coming in or going out. By creating a budget that accounts for income and expenditures, you can see where you might be able to cut back if that raise doesn’t come through or you’re laid off.
- Create an emergency fund. Socking away at least three months of living expenses in an emergency fund will help give you time to land on your feet if you lose your job. If you already have three months covered, work to build up that fund so it can last six months or more, since it may take longer to find another job during a recession.
- Pay off debt. One of the easiest ways to cut your future monthly expenses is to pay down debt — especially high-interest debt such as unpaid credit card balances.
- Learn new skills. By upgrading your knowledge and abilities, you better position yourself for the job market, should the need arise.
Recession vs. depression
As late U.S. president Harry Truman once said, “It’s a recession when your neighbour loses his job. It’s a depression when you lose your own.” While it may feel that way on an individual level during an economic downturn, that’s obviously not the official definition. So, what is a depression and how is it different from a recession? It’s simply a matter of scale: A depression lasts years rather than months, and the level of unemployment and negative economic growth is more severe. The only depression Canada has ever experienced was The Great Depression, which took place from April 1929–May 1933.
Bear market vs. recession
When stock prices decline by at least 20%, it’s considered a bear market. But what is a bear market’s relationship to a recession? Well, they can sometimes precede a recession or depression, as was the case with the Great Depression, but there have also been many bear markets that did not lead to a recession. The longer a bear market lasts, however, the more likely a recession is coming.
Frequently asked questions about recessions
What is an example of a recession?
In early 2020, there were unprecedented declines in economic activity in Canada due to the COVID-19 pandemic: Between February and April, GDP fell 17.7% before bouncing back. While short-lived, that steep decline in economic activity is the most recent example of a recession in Canada.
What causes a recession in simple terms
Many factors can cause a recession, from an extreme event that shuts down the economy (like a war or pandemic), to more subtle causes such as a decline in consumer confidence or demand that leads businesses to start cutting back on production or lay off workers.
How do you build wealth in a recession?
Create a contingency plan to deal with financial constraints that may arise during a recession, such as a job loss or a reduction in work hours. If you plan ahead by saving money in a high-interest savings account, you may have enough cash on hand to purchase investments at a discount if a recession hits, so you can participate in the full growth of an eventual market recovery.