It’s hard not to wonder if we’re slowly headed for another recession with Donald Trump’s partial rollback of Dodd-Frank and the US-China trade war causing consumer confidence to wane. However, according to a model created by Bloomberg Economics to determine America’s recession odds, the chances of a US recession at some point in the next 12 month is at 26%. This means that it would be a little early to panic, but there are reasons for concern. In the breakdown below, we will lay out facts on if there is an imminent recession coming or not and everything you should know.
What is a recession?
The National Bureau of Economic Research has defined a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Most people will point to a recession when there is a slowdown of economic activity due to GDP growth being negative for 2 or more consecutive quarters.
What are economic indicators of a recession?
There are five main economic factors for a recession:
- Real gross domestic product
- Retail sales
What is a yield curve?
The yield curve shows the difference between the interest rate on short-term and long-term government bonds. The yield curve is said to be inverted when the long-term interest rates fall behind the short-term interest rates. The yield curve is a good measure in how confident investors are in the economy and has historically been a good predictor of a recession. However, there are many economists out there that think the yield curve doesn’t mean as much as it used to due to the Federal Reserve raising short-term interest rates, putting downward pressure on long-term rates and skewing the shape of the yield curve.
When was the last recession?
The Great Recession was the worst financial crisis in the United States since The Great Depression in the 1930s. The Great Recession was caused by multiple factors, but the main cause was the lack of banking regulations. The subprime mortgage industry crashed because lenders persuaded people who weren’t qualified for conventional mortgages to get a subprime mortgage instead.
While different mortgage types suit different priorities people may have, lenders weren’t concerned about the well-being of their customers. They made risky moves by giving out loans, but also, no one was telling them they couldn’t. The banking industry as a whole was at fault. As a result, homeowners couldn’t afford their homes and many had to foreclose on their property. There are multiple parties who were responsible, but the lack of regulations were the cause of The Great Recession.
What is the difference between a depression and a recession?
A depression is when a recession lasts long enough. A depression will last several years, while a recession is usually for two or more quarters. In looking strictly at unemployment, a depression can swell to 25% as in 1933 vs. the 10% that a recession can rise to.
How to prepare for a recession?
The next recession is inevitable as recessions are an economic reality, so it makes sense to have a plan in place for preparing for the next recession. For those not prepared to ride out the short-term effects, the impacts can be long lasting.
Below are some important things you should do in order to prepare and ride out a recession:
- Build a nest egg
- It is generally recommended that you have at least six months’ expenses in savings. While it may be tough to stomach lower interest rate returns as compared to high-yield stocks, the whole point is that this is your emergency savings that you can comfortably rely on.
- Have minimal debt
- During a recession, debt can be damaging when you don’t have the financial resources to stay on top of your payments. Credit cards can really hurt you in a recession if you can’t pay off the balance, with the average credit card interest rate around 17%.
- Continue to stay on top of the job market
- With income and employment hurting the most in the last recession, getting additional certifications and training in your field to increase your value or look to change jobs to a more high-demand occupation can help make sure you continue to find viable work within the same pay range.
- Take a long-term approach with the stock market
- One of the worst things you can do in a recession is panic and sell off all of your stocks. You should invest for the long term and not just the short-term, as stock markets typically recover quickly after a recession. The key is to not sell during the next recession and put a portion of your portfolio in low-volatility investments, such as Treasury bonds. However, the persistent low-interest-rate environment we’ve been in for the last decade makes them a low-return asset to own for the long term, so make sure you fill out your portfolio with higher-interest stocks that may see short-term drops, but will also allow you to get those long-term gains.
- Buy during the recession
- While a recession comes with terrible financial implications, it also opens up a great opportunity to buy stocks at a low point. This is why it makes sense to set aside some money in an investing account to be able to invest when the market does drop.
What happens in a recession?
Real economic harm occurs in a depression that can be long lasting and even a return to economic growth does not mean that the economy is fully recovered. With the Great Recession, the economy came showed growth in the back half of 2009 with unemployment rates peaking 4 months later, double the rate when the recession started. On average, US household income fell 10% after the Great Recession due to the unemployment rate with a lot of the population taking jobs that were far lower paying than they had previously.
Is the US-China Trade War taking us into a recession?
A recently published Bank of America Merrill Lynch survey shows that 43% of respondents are expecting a US recession next year. A lot of this has to do with the tariff increases by China and the US that are proving there is no end in site for the trade war, pushing the global economy closer to a big slowdown. Robin Xing Ziqiang, a Morgan Stanley Analyst, believes that the trade uncertainty could bring the global economy closer to the point where the corporate sector would take a sever hit and have companies pull back on capital expenditure, cutting more jobs. The tariffs on consumer goods are seen to be particularly damaging as these don’t have many substitutes outside of China. China is already in the midst of an economic downturn, spurred on by Trump’s trade policy, consumer spending, and China’s reliance on growth via debt. Based on President Trump’s track record, we may see him pivot on his stance and get a trade truce on short notice, but nothing seems imminent.
How does the Dodd-Frank Act fit into the concern of a recession?
Trump signed into law a partial rollback of the Dodd-Frank Act. This partial rollback doesn’t erase everything The Dodd-Frank Act was meant to do, but it does undo some important things. Debt to income and value ratios that restricted overspending and reporting requirements are no longer under a microscope. Banks were required to be more transparent with their customers with The Dodd-Frank Act. This is no longer the case.
The Dodd-Frank Act was put into place to prevent another recession. It was also created to prevent the usage of taxpayers’ money as a bailout. With this partial rollback, we’re already steering in the direction of another recession. Even though big banks are unaffected by this change, regulations are being lifted and a partial rollback was signed into law. This means there is room for more changes in the future.
Is there a benefit to a recession?
There is a slight benefit of having a recession in that it helps with inflation, which is the main goal of the Federal Reserve in balancing between preventing inflation without triggering a recession.
The bottom line
Our economy operates in cycles so it is only a matter of time that a recession will hit. Throughout the U.S. economy’s history, we’ve seen economic downturns and have continued to recover. The best thing to do is to make sure you are financially ready for the next recession when it does hit, as many people feel the market is due for a correction in the next year or so.