U.S. Economy Tagged With Recession Label As GDP Falls Again; Dow Jones Rallies

The U.S. GDP falls for the second quarter in a row, technically putting the country in a recession. However, many argue that this label does not reflect the current state of the economy. The Dow Jones has rallied recently in spite of the news.

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May 14, 2023 • 3 min read

Inflation-adjusted, the U.S. economy shrank by 0.9% in the second quarter. The unrevised growth of real GDP in the first quarter was 1.6%. This report was eagerly anticipated, even more so in Washington than Wall Street, because the rule of thumb states that consecutive quarters with negative GDP growth is consistent with recession.

The Dow Jones Industrial Average rose on Thursday, despite the U.S. being tagged as in an unofficial recession. The Dow Jones Industrial Average added 0.6% to its previous day's rally just before midday. The S&P500 gained 0.6%, and the Nasdaq Composite 0.4%.

The Labor Department also reported on Thursday that the number of new claims for unemployment benefits fell by 5,000, to 256,000 during the week ending July 23. The previous week's figures were revised upwards by 10,000, to 261,000. The number of claims hasn't been so high since November last year.

The Biden administration has reacted to the idea that two quarters with declining real GDP is equivalent to a recession. Federal Reserve Chair Jerome Powell said on Wednesday that 372,000 net new hires in June is not consistent with recession. This implies a decline in real income and spending.

These figures may be revised. Powell said on Wednesday that recent weakness in the Labor Department’s monthly household survey is used to calculate the unemployment rate. IBD's analysis of federal employment and income taxes deducted from employee paychecks showed a rapid decline that calls into question official job numbers.

The Business Cycle Dating Committee of the National Bureau of Economic Research makes official recession designations. These are not made in a timely manner. Their economists will take as long as necessary to pinpoint the exact month in which the recession began. They rely on data that hasn't been available for several months. The committee announced that the U.S. entered recession on December 1, 2008, but data wasn't available until many months later.

In the interim, there's no way to call a recession definitively. Negative growth in consecutive quarterly periods is a reasonable measure, but it doesn't always provide the correct answer. In 2001, for example, there were two quarters with negative growth. However, they were not consecutive. The U.S. economic growth in the second quarter 2008 was 2.5%, even though, retrospectively, the recession had already begun.

The Commerce Department releases a gross domestic income (GDI) as well. Both GDP and GDI are supposed to have the same value, but due to imperfect data, there is often a statistical discrepancy. Some economists believe that when the changes in GDP and the GDI are not equal, averaging them will give a better picture of economic growth.

Real GDI grew by 1.8% in Q1 despite a real GDP decline of 1.6%. The average of 0.1% would indicate a slight growth in the U.S. Economy. The GDI for Q2 has not yet been released.

Personal consumption expenditures increased GDP by 0.7 percentage points in Q2. Gross domestic private investment, including residential housing, business structures, and equipment investments, reduced GDP by 2.73 percentages points, most of which was due to lower inventories. Net exports contributed 1.43 percentage points to GDP, while government expenditures were a drag of 0.33 percent.

Markets have rallied on the hope that U.S. economic weakness will be just enough to allow inflation to rapidly decline without crushing earnings. This could pave the way for a rate reduction in the first half 2023.

Many things could go wrong. The Fed is likely to continue raising interest rates while shrinking its balance through the fall, as the economy continues to struggle. This is not good news for stocks. Stocks only recovered when policymakers signaled that they were retreating, by pausing rate increases and phasing-out their balance sheet tightening.

A Dow Jones rally and other stock market rallies could also make it harder for the Fed to do its job, as they would be able to boost demand through a wealth-effect, which may slow down inflation's decline. This could lead to rates remaining higher for longer.

Tax data flashes a huge red flag; what it means for S&P 500

The Dow's loss from the peak of Jan. 4, which was 12.5%, has been reduced to 12.5% by Wednesday's closing. S&P 500 has recovered 9.7% of losses, and is now 16.1% below its peak. The Nasdaq is up 13%, but still 25.1% off its peak.

In the lead-up to the Fed meeting on September 20-21, the next two inflation and job reports will be crucial. This will determine if the next rate increase is a 75-basis point move or a half-point.

To stay informed about the current market trends and their implications for your trading decisions, read IBD's The Big Picture daily column.