What the Concept of a 'Business Recession' Means for Investors

On Monday, the CEO of United Airlines (UAL), Scott Kirby, made an interesting comment to a journalist at an aviation conference in Istanbul. Kirby, who is well placed to judge these things based on the mix he sees between personal and business travel bookings, said, “I think actually, in the U.S., we're in a business recession, and the consumer is just fine, the consumer is strong.”

That concept, of hard times hitting businesses more than individuals, is not what people usually imagine when they think of “recession.” Typically, it is the opposite, where people lose their jobs and suffer in order to protect the wellbeing of “the company,” and the executives and managers who fire them do just fine. In fact, a business recession that doesn’t harm consumers should, in theory, be impossible. If businesses are cutting back, that usually means lower wages and job cuts which obviously hurt workers. 

There is, however, evidence to support Kirby’s theory and observations. The two charts below are from the St. Louis Fed. The top one represents business investment over the last year, and the bottom shows personal consumption expenditures over the same period.

 

As you can see, businesses are cutting back, but individuals are still doing pretty good impressions of drunken sailors when it comes to their spending habits. That all makes Scott Kirby’s assertion look quite astute, but it prompts two important questions: How can that happen, and how long can it last?

There seem to be two factors that are making this weird economic trend possible.

The first is that the U.S. is outperforming most of the rest of the developed world economically. The Bank of England has warned of a coming recession as they battle inflation that just dipped below double figures but was still at a worrying 8.7% in April. Meanwhile, the ECB is still raising rates, despite legitimate fears of a market slowdown there. In Japan, where the economy has been pretty stagnant for decades, GDP is increasing at an annual rate of around 0.5%, so really more of the same, and China’s last reported 4.5% growth was better than expected, but still well below what the world has come to expect.

The impression that gives of weaker economies beyond America’s borders was reinforced just this morning when the Trade Balance numbers showed strength in imports relative to exports. We are still buying, but the rest of the world is cutting back. Businesses are far more sensitive to conditions outside the U.S. than consumers are, and will have seen overseas business declining, leading to them instituting cutbacks, even if domestic business is still okay.

Second, the jobs market has been strong here for a while, with shortage of labor a real problem. Even as some companies are cutting jobs, the unemployment rate is still low, and wages are still rising. That leaves consumers feeling confident, while simultaneously squeezing margins for businesses even more as wage pressure increases. Both of those things are at least in part because of the unique distortions wrought by the pandemic, where economies shut down almost completely then geared back up in a way and on a timescale that had never been seen before. So, if they are the results of a temporary phenomenon, are they themselves just blips, or will the economic pressures that resulted last for some time?

Of course, we cannot know for sure what the future holds, but the declines in business investment shown in figure 1 above are worrying from a longer-term perspective. If businesses aren’t investing, that can't help but have an impact on future growth potential, even if consumers are still feeling flush right now. That is why the concept of a business recession concurrent with economic strength is so unusual. But at some point, either the business cutbacks will hurt consumers, or consumer resilience will rescue businesses. At least, may be true in the U.S., but if the rest of the world continues to struggle, then contagion and a full-on recession in the U.S. is by far the most likely outcome given that, for all its economic power, America still only accounts for well below 20% of global GDP.

So, for investors, if domestic economic data and conditions continue to send mixed messages, as they have been doing for most of this year so far, keep an eye on what is happening elsewhere for clues as to what to expect in the fall and beyond. If the developed nations of Europe and Asia continue to struggle, the business recession will prove contagious. On the other hand, if they show signs of recovery, U.S. businesses will start spending and investing again and the decline in those areas so far this year will cause just a slight softening in the economy through the summer, then be followed by a strong bounce towards the end of the year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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