When you see the stock market tumbling,
the Fed cutting interest rates,
or a grim jobs report, you might ask yourself:
is this it?
Are we headed for another recession?
Well, that's a tricky question to answer because recessions are notoriously difficult
to predict.
However, there are some key indicators you can look to to help determine if a recession
might be on the horizon.
First what is a recession?
A recession is a broad-reaching, significant decline in economic activity that lasts more
than a few months.
Basically, instead of growing, the economy contracts.
There are several crucial factors that make up a recession.
One is gross domestic product, or GDP, which is a measure of all the goods and services
produced in an economy.
GDP helps economists keep an eye on how well or how poorly the economy is doing as a whole.
Economists look at GDP growth as one potential predictor of an impending recession.
GDP growth is how the GDP increases or contracts over a given time period.
Look back at 2007: GDP was expected to grow at 2.5% cumulatively that year, but in the
last quarter, it actually contracted by 0.2%.
And compare that chart to the Federal Reserve's GDP recession indicator chart.
Perhaps the biggest thing it indicates is just how little warning we may have before
a recession hits.
Decreased production isn't the only factor of a recession.
Real income tends to drop and unemployment tends to rise.
For example, back in October 2009 at the tail end of the Great Recession, unemployment hit
a peak of nearly 10.1%, its highest level since 1982.
One thing to keep in mind is that the Great Recession is actually an outlier when it comes
to how much damage a recession can do.
In addition to reaching 10.1% unemployment, GDP declined by more than 5%.
Other recessions have seen GDP declines closer to 1% or 2% and unemployment of 5% to 7%.
You'd have to go back to the early 80s to find another recession with more than a
3% decline in GDP.
In other words, recessions vary in size and impact, aren't always catastrophic, and
are a normal part of the economic cycle.
While recessions can be difficult to precisely predict, there are usually a few clues before
one begins.
Now, you might think a market selloff would indicate that the economy is going south,
but it's important to remember that the stock market is not the economy.
While recessions often coincide with market downturns, that's not always the case.
For example, in the first half of 1980, the economy was receding, but the S&P 500 increased
by more than 16%.
Beware of tying an overall recession to a single-day or single-week market contraction.
When it comes to predicting a looming recession, there is one remarkably reliable indicator:
the yield curve.
The yield curve is a chart that shows the yield of Treasuries with different maturities.
The yield curve inverts when the yields for longer-term Treasuries are lower than shorter-term
Treasuries.
This happens when investors expect economic growth to slow.
For the past 50 years, the yield curve has inverted within six months to two years before
every recession.
In March 2019, the yield on the 10-year Treasury note dropped below the 3-month Treasury bill.
But the yield curve inverting does not mean a recession has already started.
Another indicator is consumer confidence, which is a measure of how consumers are feeling
about economic conditions.
Consumer confidence hit a peak in March 2018.
A decline of 15% or more in consumer confidence could spell trouble, but consumer indices
are volatile.
And this metric is fairly slow; by the time everyday consumers start spending less, there's
a chance a recession is already happening.
Still not sure?
Look to manufacturers.
The Institute for Supply Management, or ISM, releases a monthly survey of manufacturing
activity like orders, inventories, and hiring.
That data is culled into an index called the Purchasing Manager's Index, or PMI.
The number to look for is 45.
It's uncommon for this index to go below 45 without a recession also showing up.
Briefly in 2015 and 2016, the PMI dipped below 50 but soon rebounded.
The bottom line is: the economy is unpredictable.
There are some indicators that signal hard times could lie ahead, but there's no way
to know for certain if or when a recession might hit.