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Should You Be Getting Ready for the Next Recession?

August 6, 2019

Floyd Saunders is the Author of Figuring Out Wall Street, first published in 2009 and it covered the last great recession. Opinions are my own. 

 

Nobody wants to see another economic downturn, but every economy has cycles. The current economy has been growing for ten years, making it one of the longest lasting growth cycles in history.

 

That in itself suggests some caution might be needed. Three early warning signs of a possible recession in the U.S. economy are raising at least yellow if not red flags, the yield curve on U.S. Treasury bonds; the latest numbers for the Gross Domestic Product and a decline in auto sales.

 

 

 

Here’s more about the early signs of the next recession and what you should be doing to be prepared.

 

The Yield Curve

 

The first indicator is the yield on ten-year U.S. Treasury notes sank to 1.73% on Monday, close to completely erasing the surge that followed the 2016 election. At one point, they yielded 32 basis points less than three-month bills -- that’s the most extreme yield-curve inversion since the lead-up to the 2008 crisis.

 

When interest rates on 10-year Treasury bonds fall below those on three-month bonds you have a strong early indicator of a pending recession, and we have seen that warning get triggered just this week.  The yield curve has historically been among the best predictors of recessions.

The yield curve essentially shows the difference between the interest rate on short-term and long-term government bonds. When long-term interest rates fall below short-term ones, the yield curve is said to have “inverted.”

The yield curve is a measure of how confident investors are in the economy. In good times, investors expect higher interest rates in return for tying up their money for longer periods.  But any sign or a recession and bond investors are willing to accept lower rates in return for the safety bonds offer.  One caveat, it can take as long as two years for a recession to follow a yield-curve inversion.

 
 
GDP Numbers

Real gross domestic product (GDP) increased 2.1% in the second quarter of 2019, according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 3.1&.

 

 

The second caution flag is the most recent GDP numbers show U.S. economic growth decelerated in the second quarter, based primarily on a decline in manufacturing, business investment, exports and inventories.  

It was only a surge in consumer activity that helped the latest GPD numbers, coming in at 2.1%. vs. the expected 1.8%. Remember, consumer spending as measured by the GDP numbers comprises about 70% of U.S. economic activity.

This slowing in the economy comes exactly 10 years since the Great Recession ended, and makes it more likely that at least a mild recession is just a head.

 

Economic expansions, often provide some early sign about when they are nearing their end — and a slowing in the GDP numbers, along with an inverted yield cure are both early signs of a slowdown before year end. 

You can expect the Federal Reserve to once again lower interest rates, keeping the cost of borrowing low.

Auto sales

Cars are the second most expensive purchase for many families. When new car sales are strong, it’s a sign consumers are feeling good. Retail car sales have typically peaked before recessions, then dropped sharply once one began. So it isn’t a great sign that auto sales are falling.  According to Investor's Business Daily, all major automakers saw new-vehicle sales decline over the first six months of the year.

 

Here are some other indicators to watch:

 

 The Unemployment Rate

Right now the unemployment rate is near a 50-year low, but  what matters for recession forecasting is the change. When the unemployment rate rises quickly, a recession is almost certainly on its way or has already arrived. Right now the unemployment rate should be a source of comfort: Not only is it low, it’s trending down.  Historically, this says there is less than 10% chance of a recession within a year.

 

The ISM Manufacturing Index

Every month, the Institute for Supply Management surveys purchasing managers at major manufacturers about companies’ orders, inventories, hiring and other activity. It then aggregates those responses into an index of manufacturing activity. 

 

When readings are above 50 it indicate that the manufacturing sector is growing; below 50, it is contracting. 

When the index falls below about 45 for an extended period, that’s indicator the economy has slipped into a recession.  

 

 

 

 

 

It is rare for the index to fall much below 45 or so without a recession close behind. As of June, the index is still in expansion territory, but barely. Many economists think it will fall below 50 in the coming months.  

 

Consumer Sentiment

It is pretty much impossible for the economy to keep growing when consumers think they should be holding onto their dollars rather than spending. Watch for Declines of 15 percent or more over a year.

The trouble is, by the time spending slows, a recession is probably already underway.

 

Sentiment had started slip toward the end of May, declining to 100.0 as
consumers grew increasingly concerned
about the impact tariffs would have on prices. (CNBC report, June 29, 2019.)

 

Consumer confidence is basically flat compared to a year ago, but it has fallen since late last year.

 

 

No single indicator can tell the whole story United States economy, so it pays to keep an eye on a variety of data sources.

 

Get ready For The Next Recession

If you are prepared for the next recession, then the impact might be less for you personally and for your business.

 

Pay off Credit Card Debt

While this is always a good idea, it is especially important to improve your cash position going into a recession, so pay down or pay off any open credit card debt as soon as possible.

Review Your Investments

Maybe your stocks have seen some solid gains and it times to trim back and take some of those gains as cash you can tuck away in a money market fund or you haven’t rebalanced your retirement fund to get the proper balance between stock and bond funds.  This might be a good time for a financial review.

 

Build up Your Cash Reserves

This can be especially important if you become unemployed or your business is dependent on consumer spending.

 

Develop a Staffing Contingency Plan

If you are an employer, make sure you know who your key employees are and figure out what incentives you need to have in place to retain then. Chances are you are doing this anyway, because the recent low unemployment means that more people are likely to seek better paying positions now than in a recession.  But for employers who have to know who to let go and who to keep when a recession hits.

 

Firm Up Your Bank Credit

If you haven’t reviewed all of your financing lines available to or provided your banker with recent financial statements now is a great time to do that while the economic picture is still solid. Banks are less likely to lend money to marginal customers in a recession, so make sure you have a solid relationship with your banker.

 

Talk With Your Suppliers

Make sure any credit arrangements for goods and services needed to stay in business and maintain inventory levels are solid, as are your payment plans for anything your vendors carry on a credit line for you. Suppliers are going to be more concerned about cash flow in a downturn too, so make sure your arrangements are solid and the vendors your deal with are financially sound as well.  When it comes to key suppliers always have an alternative source if needed.

 

We can expect an economic downturn to be shorter this time around or at least hope that is the case, nobody wants to returns to the days when 500,000 to 600,000 layoffs are occurring on a monthly basis.

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