What a wild ride the last couple of months have been.
On Dec. 4 the Dow Jones Industrial Average tumbled by almost 800 points, only to rally nearly 800 points three days later. That following Monday, it fell again by close to 500 points, but then recovered to end positively for the day.
A few weeks later, we entered into what is now the longest-running government shutdown in history, with no end in sight.
These events and others have many people wondering if the next recession is looming. The short answer: maybe. Here’s what you need to know about a possible recession and how to prepare for one.
Are We Headed For A Recession Soon?
Here’s the thing: There’s essentially always a recession on the horizon. That’s because recessions, which are often defined as periods of significant economic decline that last at least two consecutive quarters, are a natural part of the economic cycle, according to Zhi Li, owner and financial planner at Twelve Two Capital. “It is reasonable to anticipate that a recession will happen sometime in the future and reasonable to think one might happen soon given the long expansionary period that we are in,” he said.
But as far as predicting when, exactly, a recession will happen, you might as well consult your magic eight ball. Although there are a few data points we can look to when predicting an approaching recession, nailing down a specific time frame isn’t possible. Even so, plenty try.
According to Li, most economists don’t predict a recession will happen this year, but they do think one is likely to happen within the next two. Here’s why.
Signs A Recession Is Coming
Whether or not a recession will occur soon depends on who you ask.
Take the Conference Board’s Leading Economic Index, for instance. It examines 10 leading economic indicators to arrive at a growth or decline rate for the economy, and it helps predict recessions in the months leading up to the downturn. In November, the LEI grew by 0.2, which signals that our economy is still humming along though growth has slowed a bit.
Then again, other common economic measures say otherwise. Here are a few reasons why we might actually experience a recession soon.
1. Stock Market
Stock market performance is often considered a strong indicator of overall economic health. And historically, stock market peaks have preceded economic downturns by an average of seven to eight months (the actual range is a lot wider). On Oct. 3, the Dow Jones hit its highest closing record for the 15th time in 2018 at 26,828.39, following the record-setting day prior.
Less than three months later, the stock market experienced the worst December since the height of the Great Depression.
Even so, you should take these “signs” with a grain of salt. As the late Nobel Prize-winning economist Paul Samuelson joked decades ago, “the stock market has predicted nine of the last five recessions.” Certain stock market behavior can signify a recession is coming, but by no means heralds one.
2. Yield Curve
A somewhat more reliable indicator is the yield curve on U.S. Treasury securities. “Historically, when the yield curve inverts ― the interest rate on shorter-term treasury bonds is higher than the interest rate on longer-term Treasury bonds ― a recession can sometimes follow,” said Rockie Zeigler III, a certified financial planner and owner of RP Zeigler Investment Services.
How closely are the two correlated? Let’s just say the curve was inverted prior to the past seven recessions. In early December, the front-end of the yield curve inverted for the first time in more than a decade, meaning the yield on 5-year Treasury notes dropped below the 2- and 3-year notes.
3. Job Market
Another major number that could point to an imminent recession is unemployment. And counterintuitively, it’s a low rate of unemployment that often signals a slowdown.
Recently, unemployment dropped to 3.7 percent ― a nearly 50-year low. Wages are also growing at the fastest rate since 2009. According to Forbes, strong job market statistics like these indicate that we’re reaching the end of the latest economic cycle rather than the beginning. In fact, an unemployment rate below 4 percent ― which is quite rare ― has often immediately proceeded past recessions.
Finally, as mentioned above, recessions are a normal part of the economic cycle. “While it’s not a very technical indicator, a long run of economic expansion can tell us something, too,” Zeigler said. “We haven’t had a recession or bear market since 2008-2009. The economy has been expanding (albeit slowly) since then. So have the stock markets.”
For these reasons, Zeigler said, we might actually be overdue for slowing economic growth, if not a recession.
What Does This Mean For You?
Zeigler added recessions impact the average person in two major ways. The first is unemployment: “When a recession hits, generally it’s accompanied by rising unemployment,” he said.
The second is spending. “If a person is able to keep their job, they probably won’t be completely confident in spending their money on things like TVs, cars, homes and services because of all the negativity that accompanies a recession,” Zeigler said. “Our economy is very dependent on consumer consumption of goods and services and folks tend to ‘hunker down’ during recessions because they fear losing their job.”
That means regardless of when the next recession hits, it pays to be prepared.
Build up your emergency fund. According to Bradley Nelson, president of Lyon Park Advisors, your top concern during a recession should be staying on top of your bills and ensuring you have a reliable source of income.
“Everyone should have an emergency fund of three to nine months of mandatory expenses, depending upon their circumstances,” Nelson said. “A money market account is a good place to have this stashed.” He also suggested thinking about what skills and resources you have at your disposal in case that fund isn’t enough, including spouse employment, side hustles and part-time jobs.
Know your risk tolerance. Though it can be difficult to predict your own behavior during certain situations, you should ask yourself what you’d do if the market were to drop by 10, 20 or even 50 percent. “If the answer sounds like ‘I’d sell everything to preserve what’s left,’ alarm bells should go off,” Nelson said. “It’s a sign your portfolio doesn’t match [your] risk tolerance.”
If that’s the case, you should reexamine your asset allocation. “Better to come up with an allocation you can live with through thick and thin now, rather than wait for markets to drop and sell your assets at fire sale prices,” Nelson said.
Take advantage of rock-bottom prices. Even though continuing to invest during a major market downturn might feel like lighting money on fire, it’s actually the smart thing to do in most cases. “Investors should have a shopper’s mentality. This means... having a shopping list of quality products to buy at bargain prices,” Nelson said.
In other words, you should aim to sell high and buy low. And though it’s probably hard to think of a recession as an opportunity, for the savvy investor, that’s exactly what it is.