The last couple of months have seen a significant amount of market volatility both in North America and abroad. Market fluctuations have been so sporadic and random, they have even the sharpest market experts confused; is a recession coming?
What is the average investor supposed to do when the wall street geniuses are struggling?
Current news stories and headlines surrounding the market are dominated with flashy shock and awe language. Most of which seem quite bleak. A lot of these articles are talking about recessions, market volatility, and recession indicators.
What is a recession indicator? As you can probably deduce from the name, it is something that indicates a recession is coming, is imminent, or has already taken effect.
Below we look at some of the most well known recession indicators that you should be paying attention to.
The yield curve is one of the most used and most reliable indicators of a recession. When the yield curve inverts, there is a high correlation with a recession happening within two years.
Yield curve inversion happens when interest rates for short-term (i.e., 3 month, 2 year) debt instruments are higher than interest rates for long-term (i.e., 10 years) debt instruments. We talked about this in a previous post How to Prepare for a Recession in Canada – 2019.
Below is a chart showing the correlation between the 2-year bond yield and the 10-year bond yield. The light grey segments are recessions. Before each recession the yield spread dropped below 0.
The last time the yield curve inverted was… March of 2019.
Employment data is a lagging indicator. This means that when a recession hits, unemployment usually takes a couple of quarters to follow suit.
When a recession hits, unemployment usually goes up. This is bad for the economy because consumer spending makes up about two thirds of the economy. Less people working, the less money they have to spend.
You might be thinking that we don’t have to worry about this with our current historically great employment data. If that is your belief, you would be greatly mistaken.
At some point unemployment can not go lower. We are at a point of the lowest unemployment we have had in a long time. That being said, we might be closer to having unemployment increase then we would like to admit.
Furthermore, remember that unemployment is a lagging indicator. It won’t tell us when a recession starts, but it definitely tells us when we are in the midst of one.
For most, a large portion of personal net worth is tied up in their primary residences for the majority of their life. So when the housing market is doing well, it increases consumer confidence.
Housing prices are generally seen as a lagging indicator. Just before and during the last five recessions, housing prices have seen significant decline. This was extremely evident in the 2008 financial crisis. Below is a chart similar to the one above showing the relationship between housing prices and recessions.
Housing prices might be a little more of a concern for the average Canadian. Across Canada housing prices have been hit with some troubled times. With housing prices going down, we could be getting much closer to a recession.
Gross Domestic Product
The technical definition of a recession is two consecutive quarters of declining economic growth. The general measure of economic growth is GDP. So when GDP has two quarters of declining economic growth back to back, we are in a recession. For this reason, it is important to pay attention to the quarterly GDP reports.
Although economics is a lot of numbers and stats, peoples emotions can play a large role. When people feel confident about the economy and the market they will spend and invest more. When they feel discomfort with the economy and market, spending and investing dry up.
For this reason confidence indices are a great tool to measure consumer and investor sentiment. One great index to use is CNN’s Fear and Greed Index.
Share your thoughts with us!
If you enjoyed this article please like, comment, and share it with your friends. Also, follow our blog for great original content every week.
Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy