What Happens in a Recession and Are We Headed Towards One in 2022?

Global economic projections have whipsawed over the last two years. In the first quarter of 2020, it seemed that the global economy was headed for the worst recession since the Great Depression. However, as the year drew to a close, economists were arguing whether the pace of recovery was L, W, V, or U shaped.

The global economic recovery continued in 2021 but it seemed that the growth would slow down in 2022. Russian President Vladimir Putin had different plans and invaded Ukraine. The resultant turmoil has raised fears of a recession and stagflation. What happens in a recession and could the U.S. economy see one in 2022? Also, how can you survive a recession?

The technical definition of a recession is a fall in GDP for two consecutive quarters. The U.S. economy went into a recession in 2020 amid the COVID-19 pandemic. It was preceded by a historic 11-year long economic expansion.

Recessions are common and form part of the business cycle. In a recession, there are widespread job losses. As companies see a slowdown in their sales, they slow on hiring but also lay off workers. This creates a domino effect and job losses lead to an additional slowdown.

Since consumers are less certain about their future income, they cut down on expenses, especially discretionary expenses. This collective behavior to postpone spending also adds to the economic recession.

Stock markets crash during a recession. The stock markets start to fall even before the recession takes place. Similarly, stocks bottom out before the economy. Asset prices fall during a recession and consumer confidence comes down. Falling stock markets add to the negative sentiments during a recession.

Treasury Secretary Janet Yellen doesn't think that there would be a recession in 2022 but warned of high inflation. However, the probability of a recession in 2022 looks much more probable now than a few months ago. Russia’s invasion of Ukraine has pushed commodity prices, including crude oil, to multi-year highs. Global oil prices made their all-time highs in 2008.

Higher energy prices invariably fuel inflation. Also, since spending on gas is a nondiscretionary expense, consumers have less money to spend on other goods. U.S. inflation is running at almost four times the levels that the Federal Reserve is targeting.

The Fed is expected to raise rates at its March meeting, and there could be multiple rate hikes in 2022. While the rates hikes might help lower inflation, they will invariably dampen economic growth.

The global supply chain issues have only worsened amid the Russia-Ukraine war. If the Russia-Ukraine war spreads to Europe, the chances of a recession will increase. Also, a possible bond default by Russia could have a domino effect for other emerging markets.

Given the current economic scenario, a recession in 2022 doesn't look like a base-case scenario. However, there could always be a black swan event that could push the economy into recession. The biggest risk currently looks like the rise in energy prices. If crude oil prices rise towards $200 per barrel, it would increase the possibility of a recession.

If you're an investor, you might need to take a hard look at your portfolio. While it isn't advisable to fully exit stocks, it would be prudent to pivot from cyclical stocks to defensives. If you are heavily leveraged, you should look at ways to reduce that.

You can also look at a tactical asset allocation and increase the exposure to safe havens like gold. Finally, always keep a minimum of three-months worth of your spending in liquid assets, which can be useful in case of an unfortunate job loss.

If you face a loss of income during a recession, you can look at ways to boost your income and lower your spending. There are multiple ways to supplement your income like freelancing, part-time gigs, and selling on e-commerce platforms. You may even rent out your spare space to earn some extra money.

If you are cash-rich, a recession could be the best time to buy fundamentally strong stocks at attractive valuations. However, always go for a staggered buying instead of buying everything at one go.