4 Key Indicators to Monitor for Signs of a Looming Recession

Uncertainty grips Wall Street and Main Street alike, rendering fears of a larger pullback in business spending and investments. There are many contributing factors for these reasons of worry, including the U.S.-China trade war, Brexit and the "Japanification" of Europe (opens in new tab). Additionally, the American government, corporate and consumer debt levels have reached all-time-highs.

Although economies never grow in a straight line, and investors can take comfort in the knowledge that peaks and valleys are only natural, many economists see these as warning signs for a brewing recession.

Between signs of global economic slowdown, escalations in the U.S.-China trade war, negative interest rates in Europe and Japan, unchecked national debt and the longest bull market in U.S. history, investors have plenty of reasons to worry and suspect an imminent recession at the onset of every market pullback.

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Recession Sign No. 1: The Fear Factor

Numerous reports recognize that the current unstable environment is treacherous for national and global business:

• Bank of America's economists believe there is a 1 in 3 chance of a 2020 recession (opens in new tab). It concedes its formula fails to account for unpredictable factors like the trade war.
• Yahoo! Finance surveyed 100 real estate and economic experts (opens in new tab), and half of them predict a 2020 recession.
• CNBC reported that Google searches for the word "recession" quadrupled in August 2019.

Recession Sign No. 2: Falling Consumer Confidence

The CNBC report (opens in new tab) shows American consumers are worried, which may lead to a retrenchment in consumer confidence and spending. Considering that consumer spending accounts for 68% of the U.S. economy, consumer confidence is a key factor for investors to watch.

Yet despite recession fears and downward trends in manufacturing and corporate capital expenditures, consumer confidence has remained a bright spot as of August 2019. The consumer confidence index (opens in new tab) was close to its highest level in 19 years, with only a slight drop between July (135.8) and August (135.1).

A score above 100 means consumers feel optimistic and can be expected to spend more. When the score dips below 100, consumers are pessimistic and likely to restrict spending.

Recession Sign No. 3: A Worsening Trade War

During the summer of 2019, nothing stoked more uncertainty than the U.S./China trade war (opens in new tab). A quick fix is unlikely because the complexities of the trade relationship create so many points of contention. Much of the hope for a deal comes from the pressure both sides feel.

China's GDP is in decline. Tariffs, as they take their increasing effect, can be expected to harm the all-important U.S. consumer confidence, which has the potential to start the snowball that leads to lower business investment, lost jobs, credit defaults and, in a circular fashion, even lower consumer confidence.

That nightmare scenario is by no means inevitable or even more likely than a moderate slowing that reverses once a deal is reached. In fact, the governments of both countries are taking actions to prevent the trade war from doing serious economic damage, such as keeping interest rates low, cutting interest rates further and exploring a cut in payroll taxes.

These measures may help in the interim, but uncertainty will remain. Much of the economic boom has depended on trade relationships, so investors should consider any threats to them carefully.

Recession Sign No. 4: The Yield Curve

An inverted yield curve is a strange phenomenon that occurs when interest rates essentially turn upside down. Yields on longer-term bonds are lower than shorter-term bonds, which is an illogical situation that often results from investor fear and uncertainty.

Fear and uncertainty were absolutely driving factors of the August inversion of the U.S. two-year and 10-year notes. An inverted yield curve often precedes a recession since it singals that investors see more risk in the short run than the long run. Historicaly, it’s the canary in the mine for lower growth and inflation ahead.

While the yield curve merits monitoring, its predictive value cannot be assessed in isolation of global trends. Central banks outside of the U.S. continue to stimulate their economies by cutting interest rates into negative territory. As a result, 10-year bonds in Germany, France and Japan trade at negative yields, in effect charging investors a storage fee for the privilidege of investing with them.

International investors seeking some return, have fueled demand for 10-year U.S. Treasury notes, putting downward pressure on the long end of the yield curve. Concurrently, the Federal Reserve until recently has shown reluctance to cut rates, keeping the short end of the yield curve boyant.

The Bottom Line: What Investors Can Do

Whatever investors do in this time of uncertainty, there is one thing they should not do, and that is panic. The uncertainty is unlikely to go away soon, but that by no means makes a recession imminent.

The reality is that the U.S. economy continues to chug along, and a trade deal has the potential to spark a rally. But there is no certainty that a deal will be had, or that some other event will not unhinge the markets. This is no time to practice passive investing.

Investors must actively stay in touch with the pulse of the market and economy. Only then can they avoid emotional buying and selling. They should expect volatility and rely on a sound financial strategy to be their best defense when markets roil. Volatility in financial markets is a case of when and not if it happens.

Securities offered through National Securities Corporation, member FINRA/SIPC. Advisory services offered through National Asset Management, an SEC registered investment adviser. Fixed Insurance Products offered through National Insurance Corporation.