After my annual summer hiatus, there's one question I have been getting more than any other: are we in a recession? By traditional historical measures, knowing what happens during a recession, the short answer is likely yes. But the official group that declares recessions has not yet, so what are they waiting for? Here are the key data points I've been tracking this summer and what they tell us about the current state of the economy, the likelihood of a recession, and what you can do to protect your family through this phase of the economic cycle. Read on or listen to this week's episode of Finance Explained.
Are We in a Recession? Most Indicators Say YES
It's been a weird few years for finance. The markets have been more volatile than usual due to tremendous uncertainty driven first politically leading up to the 2020 election, then by a global pandemic, followed by global inflation spurred by the aftermath of the pandemic from supply chain disruptions and government spending intended to aid in the economic recovery. If you feel like your family finances have been on a bit of a seesaw, you are not alone.
Consumers, whose spending makes up 2/3s of the US economy, over the same time period went from being nervous about spending and not being able to go anywhere to spend any money, to being flush with cash from government stimulus checks and still not really being able to go anywhere, to finally spending money but facing inventory shortages, to now struggling to make ends meet as their wages fail to keep pace with inflation rates not seen in over 40 years.
You are not alone in wishing for more normalcy, more certainty, and more predictability. The good news is history tells us what we are currently experiencing is predictable. The economy follows a predictable pattern and several current indicators tell us we are likely headed for, if not already in, a recession. The current environment looks a lot like the early 1980s when the Fed had to aggressively hike interest rates to combat inflation, which induced what is now referred to as a Double Dip recession, or two short-lived, mild recessions back to back, that ultimately put the US economy on the path to more stability and expansion again.
So what indicators should you watch to help you predict what happens next? Here are 5 indicators that tell us we are likely already in a recession or headed for one very soon... and two big ones that leave others saying maybe not.
GDP Says We Are In A Recession
Back in July, just before Q2 2022 GDP was released, the White House and top officials in the Biden Administration put out official statements about what officially determined a recession, emphasizing that 2 consecutive quarters of negative real GDP growth was not enough. Why the defensive tour?
Just a week later, the Bureau of Economic Analysis released Q2 2022 GDP results, revealing a second consecutive quarter of falling GDP. Historically, this is a consistent occurrence before a recession is officially declared by the National Bureau of Economic Research, the nonpartisan entity officially responsible for business cycle dating here in the US.
As a refresher, GDP, or Gross Domestic Product, is how economists globally measure the value of all the goods and services produced within a country. Real GDP measures growth, absent the impact of price increases, or inflation. In Q1 2022, Real GDP declined 1.6% on a seasonally adjusted annualized basis, and Q2 2022 declined 0.6%, for two consecutive quarters of falling GDP.
The White House, in its statements, stressed that GDP is not the sole measure of the health of the economy. Instead...
...official determinations of recessions and economists’ assessment of economic activity are based on a holistic look at the data—including the labor market, consumer and business spending, industrial production, and incomes.
White House Blog, July 21, 2022
They made these statements just before Q2 GDP was released. And while that held true in part for Q1 numbers, Q2 GDP demonstrated declines in consumer spending on nondurable goods (-3.7%), and a double-digit decline in private investment (-13.2%) driven by both declines in residential investment - people like you and me buying homes - and by large declines in business inventories. This was likely driven by businesses being more pessimistic about the economic outlook, and selling through inventory stockpiles, some of which may have arrived on a delayed basis due to supply chain struggles, rather than investing in more inventory at now inflated prices.
Consumer Spending Says We Might Be Headed for a Recession
How about consumer spending? The US economy is extremely consumer driven because consumer spending represents 2/3s of US GDP. When consumers, that's people like you and me, feel good about the economy, we spend money and keep the economy humming along.
When we are worried about where the economy is headed, we start to pull back. We save more and spend less, especially on the bigger ticket or non-necessity items. The closest real-time barometer we have for what consumers are spending is monthly retail sales numbers.
On a headline basis, advanced monthly retail sales, which also includes restaurants, look pretty good. BUT, as we all know, inflation is up signficantly, and headline retail sales include the benefit of higher prices. If we look at Real Retail Sales for August, adjusted for inflation, they are up just +0.8% vs. a year ago, and are generally flat to down over the last 18 months.
Why are real retail sales flat-lining? Because consumer incomes are struggling to keep pace with inflation. They are depleting the significant savings they built with stimulus checks just to buy necessities, and any increase in income is more than eaten up by higher prices. We are also facing difficult retail sales comparisons. There were huge spikes in demand in 2021, driven by the accessbility of vaccines, the economy re-opening, and government stimulus checks. People went out and bought big ticket items, that they are unlikely to repeat annually, pulling demand forward.
So far, consumer spending, as measured by retail sales, seem to just be keeping pace with inflation, but as savings are depleted, as interest rates continue to rise, will they drop further? Only time will tell.
Retail Sales Updates
Advanced Retail Sales for September 2022 will be released October 14th
Consumer Sentiment Says We are In a Recession
The University of Michigan has conducted Consumer Sentiment surveys going back to the 1950s on a quarterly basis, and on a monthly basis since the late 1970s. It measures how optimistic consumers feel about their finances and the overall state of the economy. In June 2022, the Consumer Sentiment index produced its lowest reading EVER recorded. The preliminary reading for September has recovered somewhat (59.5) but still remains at extremely low levels.
Steep declines in consumer confidence nearly always signify an economic recession. In many ways, how we as consumers FEEL about the economy, actually determines how the economy will do going forward. When we feel good about the future, we are more apt to spend and the economy keeps on humming. When we are worried, we save more, spend less, and as a result, the economy as a whole slows down.
During major election years, the Consumer Sentiment survey also releases the index reading broken out by political affiliation. And I found these data points to be very telling as well, almost as if people of different political parties feel as if they are living in two entirely different countries right now. Democrats are far more optimistic both about current economic conditions (76.3) than Republicans (43.5), and the divide is even starker when asking about expectations going forward. It is these 2 surveys combined that make up the total Consumer Sentiment Index.
Given the persistent historic lows of the Consumer Sentiment Index overall over the last several months, most consumers feel as though we are likely in a recession.
University of Michigan Consumer Sentiment Survey
Final readings for September 2022 will be released Friday, September 30th
Stock Market Says We are In a Recession
The stock market is a leading economic indicator. While many argue it is not a fair representation of the whole economy, officially it is a representation of many smart investors' outlook for future corporate earnings. And those corporations, as major employers and the stock market itself as a major source of wealth in our country, have historically predicted fairly accurately upcoming economic downturns.
All recessions post-WWII have seen a 20% stock market drawdown or close to it (although, to be fair, not all 20% stock market drawdowns result in recessions). As of June 2022, the S&P 500 was down over 20% from its peak in late 2021, and after the latest Fed rate hike, the market after recovering some in recent weeks, is again down over 20%. The stock market is likely telling us we are headed for, if not already in, an economic recession.
A few other important things to note - the stock market recovery nearly always begins before the recession is officially over and each and every time, the market has fully recovered and surpasses its pre-recession highs.
Yield Curve Says We are Headed for a Recession
Every recession since the 1980s has been predicted by an inversion of the yield curve, and more specifically, a negative spread between 10-year and 2-year bond yields. What is the yield curve? It's simply a plot of interest rates for a single issuer at varying points of maturity, or most commonly, the interest rate for US government bonds from 2-3 months through 30 years.
A normal yield curve slopes up and to the right, with interest rates highest on the longest dated maturity: a 3-month Treasury bill should have a lower interest rate given its shorter time horizon, than a 30 year Treasury bond. But when investors are worried about the future the curve starts to flatten, and when we are really worried, even invert.
Why? When the economy slows down, the Fed usually acts to help stimulate it again by cutting interest rates. The yield curve, when it inverts, is predicting an economic slowdown AND future cuts in interest rates in response.
The current yield curve (shown in hot pink below) is most definitely inverted, and has been ever since the 4th of July this summer. The yield curve historically has inverted about 6-12 months ahead of an economic recession, indicating we are likely headed for a recession in 2023.
Unemployment Says We Are Not in a Recession
There's one major economic indicator that does not point to recession... yet. Unemployment.
Historically, unemployment is a lagging economic indicator - meaning it tends to rise once a recession is already underway. It comes at a lag typically due to employers reacting to the drop in consumer demand, which comes first. Employers then react to the fall in demand by trying to cut costs and preserve profits, with labor being a major cost they can cut most quickly.
Through August 2022, we have officially fully recovered the more than 20 million jobs that were lost at the height of the pandemic... and in fact, we've returned to the pre-pandemic problem faced by the labor market - a labor shortage. The Fed, historically, has generally considered 4-4.5% unemployment to be consistent with "full employment," a level that allows for new job market entrants and job switching. As of August 2022, the unemployment rate was at 3.7%, up slightly from the 3.5% low earlier in the summer, but still near all-time historical lows.
And if we model the labor market supply and demand, with the labor force representing supply and nonfarm payrolls plus job openings as total employment demand, we currently have the tightest labor market since this data was all recorded over the last 2 decades.
However, all of that is what the monthly data tells us - but recent headlines tell us there may be a shift coming. In recent weeks, more and more major companies are announcing hiring freezes and/or layoff plans. A recent survey of more than 700 executives by accounting firm PwC, indicated half said they were reducing headcount or plan to, with over 50% having already implemented hiring freezes.
Remember - unemployment is a lagging indicator, often not dropping until a recession is already well underway. Unemployment remaining low does not mean we are not already in a recession, but as of now, it doesn't tell us we are either. However, as long as it remains at low levels, the Fed has ample runway to continue to raise interest rates to attack inflation.
Employment Situation Report
The Employment Situation Report is released on the first Friday of every month.
The report for September will be released on Friday, October 7
NBER Has Not Announced a Recession
Last but not least, the National Bureau of Economic Research, or NBER, is the official arbiter of recessions in the US. They make the official declaration of the start and end of recessions. As of now, they have yet to declare a recession.
It's important to note that while, yes, the NBER looks at a multitude of economic factors other than just GDP when announcing peak economic activity, they also take their time in doing it. I took a look back at the timing of their past recession announcements. Since the 1980s, it has taken the NBER anywhere from 4 to as long as 11 months to announce the start of a recession from what they determine as the peak of economic activity. And in several instances, they announced a recession was underway after what they later determined to be the trough, or bottom point, and the start of the economic recovery.
|Recession||Peak Month||Trough Month||Peak Announced||Months After Start|
|Double Dip - Part 1||January 1980||July 1980||6/3/1980||5 months|
|Double Dip - Part 2||July 1981||November 1982||1/6/1982||6 months|
|Savings & Loan Crisis||July 1990||March 1991||4/25/1991||9 months|
|Dot-Com Bubble||March 2001||November 2001||11/26/2001||8 months|
|Great Recession||December 2007||June 2009||12/1/2008||11 months|
|Covid Pandemic||February 2020||April 2020||6/8/2020||4 months|
So, while the NBER has not officially declared us to be in a recession, that doesn't mean that it hasn't started already.
National Bureau of Economic Research
There is no official timeline or deadline for the NBER to declare a recession.
However, you can watch for an announcement on their site here.
How to Prepare Your Family Finances for a Recession
Whether or not a recession has been officially announced, there is little doubt in my mind that one is coming if not already here. You don't need to wait for an official regulatory body to announce it to start to prepare. And by the way, the reality is once it is announced, you have already been living with the reality of it for some time. Recessions are not something to fear or that can even be completely avoided. They are simply one part of the economic cycle.
What can you do to prepare? First, you're already doing it - building your knowledge to understand what happens in a recession will equip you to weather the potential impact to your family finances.
Two, the biggest risk to most families is loss of income, either from outright job loss, reduction of hours or reduced sales for commission-based employees. You can prepare by bulking up your emergency fund. Most families should have at least 3 months of monthly expenses set aside, but if you are worried about potentially losing your job, it can be smart to bulk that up even more, to 6 months savings. This will help you ride out any periods of unemployment, and cover any gaps in income while you look for a new job.
Three, work on creating a bare-bones budget. What could you eliminate immedately if you lost your job tomorrow? Think subscriptions, streaming services, dry cleaning bills - every expense you can eliminate, with a focus on just maintaining the absolute necessities: shelter, food, transportation and insurance. And even among the necessities, what can you minimize? You don't have to implement this plan immediately, but you can to help bulk up your emergency fund. And just having a plan will arm you with an action list to attack when faced with difficult times, which can often leave many families feeling helpless.
So, how can you prepare? Be informed. Be prepared. And make your plan of financial attack.