After the massive downturn in 2008, Americans have been extra wary about the economy of the country. This is understandable, considering that the savings of many were wiped out entirely during the phase and it took years for the housing market to recover, with some locations still showing the after-effects of the market crash. A serious recession makes the economy the talking point across the country and not in a good way at all. The public is seized with fear, anxiety, and panic, and all of this results in poor financial decisions that might only make the whole situation far worse than it has to be.
While most Americans have finally put the downturn of 2008 behind them and are moving on steadily, the fear of another recession is already doing the rounds. According to a recession probability model developed by Bloomberg, as of February 2020, there is a 28% chance of a recession occurring within the next 12 months. Even more alarming is the fact that the probability stood at 25% just a month earlier. Slow employment rate is one of the key factors that is contributing to the recession fear, in conjunction with subdued manufacturing data. There is clearly a frisson of anxiety running through the minds of the common public, as rumors of a recession continue to spread.
But is there any substance to the rumors? How can you figure out if there is going to be a recession now or at some point in the future? Is there anything you can do about it proactively instead of biting your nails and waiting for the crash to hit you and your finances hard? Thankfully, the answer is yes. Not only can you learn to tell when the economy is heading towards a recession, but there are also ways in which you can protect yourself and your finances beforehand so that, even if a downturn does happen, you are not as badly affected as those who are caught unaware.
Let’s start by looking at signs that tell you a recession is in the future.
Signs of an Impending Recession
Take a look at recent Google searches about the American economy, and you will see that an alarming number of people are searching for recession and recession-related terms in a bid to know if they can figure out a possible downturn in advance. There is fear in the economy, but to know if these are baseless or have some substance, you should know about the most trusted signs of a recession and how to read them.
Yield Curve Inversion
One of the most commonly watched indicators to tell if a recession is coming is the yield curve. This indicator has a good track record for being accurate. For five decades, economists and market analysts have found the yield curve shifting when a recession is about to begin. So what should the yield curve show? When does it indicate a recession?
First of all, what is a yield curve? The yield curve is a reading of the interest earned on a Treasury bond. Treasury bonds come with different maturities. The yield curve tells you how the interest rates change with the duration of these bonds. Normally, the interest rate becomes higher for longer-term bonds, the logic being that, over the longer duration, many more risks can crop up, and to compensate for them, the buyer seeks a higher reward. However, if a recession is impending, the buyer seeks a higher yield for a shorter term, and in such cases, the yield curve is downward sloping. A downward-sloping yield curve is an indicator of a possible recession coming up soon.
Manufacturing data is another important indicator that economists use to forecast recession. Although the U.S. economy is less dependent on manufacturing now than it used to be, this continues to be a reliable indicator. Manufacturing has actually contracted over the latter half of the previous year, and this has set off fears that a recession is likely to occur soon. A slow down in manufacturing means that it is up to the rest of the economy to perform better than normal to offset the impact. If this fails to happen, owing to different factors, the economy as a whole may slow down.
Following manufacturing data and keeping track of how the manufacturing sector is doing is a good move if you want to keep yourself updated with signs of recession in the near future.
In 2019 August, the manufacturing purchasing managers index (PMI) dipped below the 50 mark. Although it was a marginal dip to 49.9, it is still alarming, as a reading below 50 indicates a contraction in markets. The number went below the 50 thresholds for the first time since September 2009, setting off alarms in the minds of many investors.
It doesn’t really matter if unemployment is at a high, even though this shows that something is definitely wrong with the economy. A high figure may not directly indicate a recession in the future, unless there is a specific type of change in numbers. If the unemployment rate is steadily declining, it’s all good news, and it indicates a growing economy. If it is improving in spurts, it still isn’t cause for concern. But if the unemployment rate is rising and at an alarmingly fast pace, then it is a danger signal for sure. In fact, it could indicate that a recession is already here. Even blips that seem to be insignificant need to be taken seriously.
The unemployment rate is usually one of the last things to start showing the effects of a recession and is hence called a lagging indicator. It typically rises during a recession, and when the economy is not contracting, you will almost never see a spike in unemployment over a very short duration. Deemed a very reliable indicator of downturn, unemployment figures should be on your checklist if you are trying to spot a recession on time.
There are many factors that impact the economy, but there is no denying that it is the consumer who drives it and therefore plays a key role here. What the consumer feels about the economy does matter a lot, and it could dampen the economy if a sufficiently intense wave of pessimism is taking over the end user’s side of the marketplace.
This should also be seen in context of businesses having a more pessimistic outlook about the economy in general. A two-pronged impact could take place, driving down the economic activity and thus paving the way for recession. Firstly, consumer activity is affected – that is, sales figures dip because the consumer is wary about spending too much money. Secondly, business investments are subdued because investors are too wary about spending/investing money in a climate that hints at a possible contraction.
In short, growth remains subdued and may also stagnate as a result of consumer and business spending coming down dramatically, owing to fears of a downturn. The consumer confidence index is a good way for you to understand how the sentiment is faring at present.
How to Prepare for a Recession
In the U.S., there are quite a few reasons why the market is currently jittery about a possible recession. There are a number of global factors that contribute to the fears, making the climate even more tense. The U.S.- China issues, Brexit, the fact that stock markets are soaring but bond markets are subdued, and the poor economic state of many countries that may have some of them on the brink of a financial disaster all contribute towards a tense atmosphere here as well. While there is no clear signal to show that the U.S economy will spiral down soon, it never hurts to take precautions and be prepared to protect your wealth in case a downturn does happen.
The good news is that, if you suspect a recession is going to happen, there is plenty that you can do in advance to ensure that your wealth is affected to a much lower degree than it may be otherwise.
Pay Off Your Debts
The very first thing to do if you fear a recession is to ensure that you have no debts. If that seems to be an impossible task, then your priority should be paying off your biggest, most expensive debts as fast as you can before the spiral down begins.
In a downturn, the chances that you might lose your job are significantly higher. If you do, then your regular income is disrupted for an indefinite period. Under such circumstances, you have to dip into your savings to make ends meet until you can get another job. If you have huge debts looming over you, a large chunk of your savings goes towards paying off the debts, leaving you with very little cash for your essential daily expenses.
By paying off your debts as soon as you can, you reduce the outgo from your pockets and enable yourself to save more. When you save more, you have a bigger buffer to fall back upon during recession times. Also, with fewer debts to pay off from your savings, you have more cash to address your daily expenses. Pay off your most expensive debts first so that the burden on your finances is significantly lowered.
Boost Your Savings Rate
Did you know that you should have at least three to six months’ worth of living expenses in the form of savings at all times? As we discussed already, losing your job during recession would be the worst-case scenario that you are prepping for. If that happens, you need to have enough saved up until you can find a new job, and that could take anywhere between three to six months at a reasonable estimate. If your savings do not cover your living expenses for that duration right now, it is time to aggressively save up before a contingency is required.
The first step is for you to list out your monthly expenses for four to five months, take an average, and then estimate your average living expenses. Now you know what your savings goal is. Look for a second income, cut down frivolous expenses, and see where you can tweak your budget to improve your savings so that you can reach this goal quickly. Once you have learned to adopt a more financially sensible lifestyle, ensure that every single dollar saved is going towards your debt repayments or savings.
Make Yourself More Marketable
Alongside building up your emergency nest egg to tide you over a possible lay off, you also have to work on making yourself an attractive prospect for future employers. In a recession situation, there are still jobs to be done, but those jobs are going to be sought after by many more. To ensure that you get the job despite the competition, you have to hone your skills and build up better credentials than most of your peers. This will make you the obvious choice for an employer who is looking to hire the most efficient, most suitable candidate who can give him the best added value in a tough financial phase.
Making yourself more marketable can mean building upon skills related to your field. Maybe specialize in a specific niche that is very critical in your field of work or get more qualifications in an avenue that has just opened up here. It also means you improve your ability to market yourself, so work on your soft skills, such as communication, team work, and leadership. All will help your career prospects quite significantly.
Networking is another thing you must keep at or start doing. Networking keeps you in touch with the people who are in your field, and it also ensures that you stay updated about what’s happening and new prospects opening up in your niche.
Keep Updated with Financial News
It is important to focus on making yourself more valuable to employers and to build a nest egg that you can fall back upon if the worst happens. At the same time, you should also ensure that you are staying updated with what is actually happening in the economy so that you can act in the right way at the right time. For example, if you sense that a recession is just around the corner, you may want to take advantage of the current higher interest rate climate and move variable returns investments into fixed return avenues so that, when the interest does dip, your yield is not affected much. As experts point out, you can also take advantage of the subdued prices during recession to buy into promising equity that will give you good returns once the recession passes, as it inevitably will.
However, to do either of these, you need to be able to time your actions well, so you need to be well-informed about what is happening in the markets. Staying updated with financial news/markets and keeping track of how various industries and segments are performing will tell you which areas are good investment avenues and which are not. This helps you make wise investment decisions, be it eliminating exposure in investments you currently own or taking up exposure to those that promise future benefits.
Expect the Unexpected
Above and beyond all of this, keep in mind that even experts find it impossible to predict a recession with accuracy every time. In fact, there are very few instances when experts have actually predicted a market downturn in good time. Contrastingly, there are quite a few instances when economists have admitted that they were unaware that the economy was already well into a recession spiral. There may be factors that have nothing to do with economics, for example, political disruptions, war, natural disasters, and so on, that wreck an economy overnight or push it towards a downward spiral at an alarming rate, with no one the wiser. There is no way for anyone to be able to predict these or their impact on the economy of the country very definitely.
Keep this in mind at all times so that you do not grow complacent if you fail to notice signs of recession and give up being wise about your financial lifestyle. Making a budget and sticking to it, avoiding frivolous expenses, and making sure not one dollar more than necessary is spent are healthy financial habits that will continue to yield benefits for you throughout your lifetime. Make these an indelible part of your life. Consciously focusing on building savings, creating and nurturing an emergency fund, and planning ahead for expenses and retirement will help you create a financially secure future for yourself. Recession or no recession, these habits will enable you to live life without any anxiety about running out of money or being unable to live the life you desire now or in the future.