10 Recession Red Flags — How Many Did You Miss This Year?
In terms of the signs of a recession, none is more reliable than when there’s an economic contraction that lasts for more than a few months. That’s the definition of a recession, which the National Bureau of Economic Research officially declared the United States to have hit as of early June. That marked the end of a truly historic 128-month run of economic growth that came in the aftermath of the Great Recession.
That also marked the end of the fun game economists have been playing for the last several years: When is the recession coming and how will we know? The longer the recovery stretched on, the more there was at stake in being able to pinpoint which red flags might be the ones that actually indicated that the long party was rolling to a close. Of course, no one’s guess was “a previously unknown, incredibly contagious virus will require everyone to shelter at home for months,” but so it goes.
So what can you use to get a sense of when a period of good times is coming to a close? What signs are there that could help you to know when it might be time to try and make sure your emergency fund is a little fatter than usual? Here’s a look at some of the indicators that economists prefer.
Last updated: Oct. 7, 2020
1. More People Can’t Pay Their Loans
A rise in loan delinquencies can be linked to excessive credit growth and the buildup of household debt — which are both warning signs of a coming recession, said David Beckworth, a senior research fellow at the Mercatus Center at George Mason University. Although a large buildup of debt can be a warning sign, it’s important to remember that delinquencies can also rise as a result of a recession, Beckworth said.
Past Recessions and Loans
Past patterns of delinquency rates and recessions are not encouraging. According to the Federal Reserve Bank of St. Louis data, noticeable increases in commercial and industrial loan delinquency rates occurred during the last three recessions.
A growing economy can often be its own stumbling block, as increasing prosperity means people are more ready to loan out money. However, that easy credit also typically leads to people taking on too much debt as the economy starts to expand faster than it can sustain, and spiking delinquency rates are often a sign that the days of easy credit are numbered.
Loans and Delinquency Rates Now
It’s still a little too soon to know for sure just how the immediate consequences of the coronavirus are playing out, as economic data is continuing to trickle in. However, data from the first quarter of 2020 — the last couple months of which captured the beginning of the crisis — indicates that Americans entered this crisis with a lot of debt. Total household debt increased by 3.2% in the last quarter of 2019, but it was up by a whopping 11.7% to a total of $55.9 trillion for the first three months of the year.
Much of that was driven by the private sector, with business debt climbing by 18.8%, while household debt climbed by a more modest 3.9% — largely due to a 3.2% increase in mortgage debt. However, it’s only when the second-quarter numbers hit that economists are likely going to be able to see the real impact of the crisis on people’s checkbooks. But, with people borrowing so much more even before the pandemic hit, it seems imminently possible that many were not in good shape to deal with this sort of problem.
2. Taxes Bring In Less Revenue
During an economic downturn, states typically see a decline in revenue, according to the Brookings Institute.
State sales tax can be especially discerning of consumer confidence. A common reason sales tax revenue can come up short before or during a recession is because Americans aren’t buying enough goods and services that the government can tax. And when consumer spending plunges, recessions usually follow.
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Past Recessions and Taxes
It’s harder to draw clear one-for-one comparisons because of many other factors that also affect levels of tax revenues — public policy, population growth, changes in tax rates. However, there are noticeable slowdowns in growth during the recessions of the early 1990s and immediately after the dot-com crash.
Also, total sales tax revenues declined in 2009 while the economy was in free fall after the collapse of the housing market.
Tax Revenues Now
The significant decline in tax revenues does appear to show that a major slowdown associated with the lockdown is currently in the works. Among the sharpest areas of decline was in sales taxes, which are an essential part of how state and local governments fund their operations, comprising about one-third of total revenue. However, with so many stores closed and so many people struggling, sales taxes appear to be as much as $150 billion short of previous estimates in the wake of the pandemic.
3. Rapid Increases in Fraud Rates
Investor Michael Burry, made famous by “The Big Short” book and movie, noticed significant increases in mortgage fraud as the housing bubble grew toward its peak before collapsing and initiating the Great Recession.
“It is ludicrous to believe that asset bubbles can only be recognized in hindsight,” wrote Burry, according to “The Big Short: Inside the Doomsday Machine” by Michael Lewis. “There are specific identifiers that are entirely recognizable during the bubble’s inflation. One hallmark of mania is the rapid rise in the incidence and complexity of fraud …”
Past Recessions and Fraud Rates
Increasing rates of fraud, scams and similar misconduct can serve as a warning sign of a recession like Burry saw with the Great Recession — and they can even indicate we’re already in a recession. In May 2009, before the end of the Great Recession, Time reported, “the number of whistle-blowers reporting fraud, theft or the misuse of company assets” was rapidly increasing.
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Fraud Rates Now
Fraud is on the rise in America as vulnerable people search for solutions. In particular, online money scams are spiking as banks see most of the customers who hadn’t already adopted online banking using it now. Credit monitoring firm TransUnion reported a 23% jump in identity fraud among its customers, with scammers now building fake identities based on real people that they can use for nefarious purposes.
4. Oil Price Shocks
Rising gas prices are always a headache to deal with. But they can often pose much greater dangers than just forcing you to pay more at the pump.
Rapid increases in oil prices can be due to what is called supply shock — specifically, negative supply shock. In this scenario, the supply of oil suddenly seems to dry up, forcing prices to soar very quickly because the demand for it has not gone down. And not only will the sight of higher gas prices impact consumer confidence, but the increase in the cost of driving affects virtually every type of economic activity. From commuting to work to the trucks getting goods to market, more money spent on gas means less money for everything else.
Past Recessions and Oil Prices
The combination of having less money to spend and having everything cost more impacts consumer spending. So while higher oil prices mean boom times for people in the oil industry, they have also preceded the last five recessions.
However, this could also be the case of confirmation bias. There are a wide variety of factors that affect economic growth, with oil prices being just one, and oil prices can be notoriously fickle over time. Pricier oil can slow economic growth elsewhere, but expensive gas during a time of prosperity won’t necessarily cause a 180 all on its own. There was a brief peak in prices in 1996, for instance, that did little to arrest the internet-fueled boom times of the 1990s.
Oil Prices Now
The enormous crash of oil prices at the beginning of the pandemic really demonstrated just how drastic the situation is for oil producers. With so many people suddenly trapped at home — and so many nonessential businesses required by law to close their doors — demand for fuel plummeted around the world. And with the industry already in a supply glut, it actually pushed oil futures into the negatives as companies scrambled to find places to save the crude oil that no one appeared to have any immediate need for.
All told, Brent Crude (oil from the North Sea that’s used as an international benchmark for oil prices) was selling for just under $60 a barrel as of late February, only to see prices nosedive to under $20 a barrel by late April. Prices had rebounded to about $40 a barrel by early April, but things remain touch-and-go for the energy markets.
5. Rising Interest Rates
You might already know how interest rates affect your finances. But you might be wondering how rising interest rates can be a recession warning sign, yet also indicate a growing economy. To understand this concept, you first have to know what the natural interest rate is.
“There is an idea in economics called the ‘natural interest rate,'” Beckworth said. “This is the underlying value interest rates would naturally take given the fundamentals of the economy. The Fed’s job is to try and align itself with this unobservable rate.”
And that’s the tricky part that can cause trouble for the economy. “What this means is that for interest rates to be raised too high and cause a recession, they have to be raised above the natural interest rate,” he said.
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Past Recessions and Interest Rates
While raising interest rates above the natural rate can spur a recession, that doesn’t necessarily mean higher interest rates can be considered a sign that a recession is on the way. That’s because the Fed always raises interest rates during periods of economic expansion, and the boom-and-bust cycle of the economy means there are always periods of economic expansion preceding a recession. So, while higher interest rates always come before recessions, they also come before continued prosperity, making them a pretty unreliable sign to count on.
For that matter, it’s also important to note that leaving interest rates below their natural level can be even more disastrous. When it’s too easy to get loans, it can lead to too much speculation chasing fast profits — causing the economy to grow too fast and then crash dramatically. In fact, many would cite the low interest rates of the early 2000s — established by then-Fed chairman Alan Greenspan in response to a recession — as being a contributing factor to the creation of the housing bubble that would ultimately cause the financial crisis.
Interest Rates Now
Interest rates? What interest rates? Dropping interest rates to zero was essentially the first lever that Jerome Powell pulled in trying to stimulate the economy before he proceeded to flood the bond markets and bank balance sheets with newly created money in an effort to keep markets liquid. What’s more, Powell has already predicted that interest rates would stay that way through 2022 as the economy continues to struggle and unemployment rates remain at their highest levels since the Great Depression.
6. Decreasing Home Prices and Sales
When home prices and values start falling, many consumers respond by cutting spending as their net worth falls — at least on paper. The cutting back can get more extreme if homeowners find themselves in negative equity — also known as being “underwater” on their mortgage — when they owe more on a home than what it’s worth. And, per usual, less consumer spending can lead to a recession.
Past Recessions and Home Prices
The drop in median home prices in 1979, 1981, 1990 and 2000 are hard to miss. Not because they were especially large but because home prices rarely ever decline. Since the 1960s, median U.S. home prices have mostly marched higher and higher with a few small hiccups — making those pre-recession dips in 1990 and 2000 hard to ignore.
In fact, that faith in the reliability of rising home prices played a major role in causing the financial crisis. Many of the investment bankers trying to determine how risky their mortgage-backed securities were were operating with data that showed decades of consistent growth.
Home Prices Now
You might not need to see a lot of economic data to know that there aren’t a lot of people ready to make a financial decision as big as buying a home in the midst of so much uncertainty. Existing home sales for May were down nearly 10% from the prior month and over 25% from the year before. That represents the largest year-over-year decline since 1982 when runaway inflation pressed interest rates as high as 18%.
However, sales of new single-family homes surged more than expected that same month. So while the recent surge in new coronavirus cases is a cause for concern, there may also be some signs of life in this moribund housing market.
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7. Declining Prospects for Bellwether Companies
Certain lines of business have become important to gauge the overall strength of the economy because their products overlap with other forms of economic activity. Companies that make cardboard boxes, for instance, can help you understand the market for consumer goods. Fewer people buying things means less shipping and less packaging, meaning the bottom line for cardboard companies takes a hit.
There are certainly other companies that can have a similar effect — each in what are considered “cyclical” industries that will boom and bust along with (or just ahead of) the broader economy. Caterpillar, for instance, produces heavy equipment used in construction. When its sales fall — and its stock slumps with it — many view it as a potential red flag for a slowing economy.
Past Recessions and Bellwether Companies
You certainly can’t lean too heavily on an individual company as a predictor of how the broader economy is doing. After all, declining revenues could mean lower demand, but it could also just be a bad year for the sales team.
That said, there are plenty of cases where companies have proven to be the proverbial canary in the coal mine. European cardboard company Smurfit Kappa Group saw operating profits dive from 2007 to 2008 in what proved to be a sign of a coming storm. Likewise, if you look at Caterpillar’s historic stock chart, the company’s stock peak during the booming 1990s came in April 1997, just over two years before the S&P 500 topped out and started to retreat in September 2000.
How Bellwether Companies Are Faring Now
The stock market currently seems to be chugging along in spite of everything, regaining much of what was lost in the initial crash. As such, some major bellwethers aren’t showing a lot that reflects the otherwise dreary economic data. Caterpillar is currently trading in the $120-$125 a share range, just a tick off the prices around $140 that people were paying in late February, and way up from when prices dipped under $100 in late March. That could indicate that demand for construction equipment has yet to dip, a sign that the slowdown might be more temporary.
Aluminum company Alcoa, though, paints a different story. Long used as an insight into the demand for basic materials, Alcoa’s stock lost roughly three-quarters of its value from the start of the year to its low point. And while shares have rebounded, the company is still worth about half of what it was at the start of 2020.
8. Stock Market Crashes
Stock market crashes are probably the best-known — and easily the most dramatic — warning signs of a looming recession. A stock market crash can cause a loss of consumer confidence as people are generally less ready to spend money when their investments are in the tank. That can slow spending and create larger economic problems.
There’s also the psychological effect of the news. The chaos and panic that can grip the country as stocks seem to be falling without knowing where the bottom might be is contagious, especially as the news gets blasted across the headlines.
Past Recessions and the Stock Market
It’s worth remembering that the only thing you can really tell from stock markets is how stock prices are faring. Troubling trends in the broader economy can materialize in the form of a stock market crash, but sometimes a crash is just a return to sanity after a period of frenzied enthusiasm among stock investors.
So, while crashes in 1929 and 2008 were signs of much more serious problems with the economy, massive crashes in 1987 and 2000-01 were followed by relatively mild recessions that gave way to booming economic growth. The crash in 1987 is still the largest single-day decline in market history, but its long-term effects proved minimal when compared to the Great Depression or the Great Recession.
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Stock Markets Now
The market tumble from late February had turned into a major crash by March, but the big story with the stock markets appears to be the rebound that has plenty of people still scratching their heads. The S&P 500 even briefly returned to even on the year in early June, something that’s a little hard to believe given the sky-high unemployment rate, closed businesses and inevitable impact on demand across almost every sector.
Only time will tell if stock investors were oddly prescient about the economic impacts lagging well behind what was predicted, but it might also tell that a combination of easy money from the Fed and excessive optimism led a lot of people to snap up shares at a time when it would have made more sense to hold onto your cash.
9. Unemployment Rates Drop Too Low
It might be indirect, but there’s an interesting link between declining unemployment rates and a possible recession.
“There is not a robust relationship here,” Beckworth said. “(But) if unemployment drops too low, the Fed gets worried inflation will take off. So, it increases interest rates. If it raises rates too far then yes — it can spark a recession.”
The threshold for this to occur is very technical and defined by the Congressional Budget Office. The unemployment rate must fall to three-tenths of a percentage point or more below the nonaccelerating inflation rate of unemployment.
Past Recessions and the Unemployment Rate
It certainly seems odd to think that low unemployment can be a bad sign, but when you consider its relationship with our old friend interest rates, it starts to make a lot more sense. However, it’s worth noting that unemployment is likely to be low during periods of expansion and periods of expansion usually precede a recession. So, while unemployment is low at the end of a period of economic growth, it’s also low in the middle of one, so it’s never really that easy to draw a line between a low unemployment rate and a pending recession.
The Unemployment Rate Now
The unemployment rate currently sits at 13.3%, which is historically bad. However, just how bad it is remains an interesting question. Questions abound about how to classify people who are temporarily laid off, not to mention more important questions about just how many of them will be able to return to their old jobs in the relatively near future.
The May jobs report showed a shocking 2.5 million jobs added and a decline in overall unemployment. And while there are signs that part of that sunny outlook can be attributed to the aforementioned question about classification, it’s also clear that the data came in better than expected regardless of how you counted those people. Only time will tell just how serious the current situation is — not until the economy really reopens will it be clear how quickly people can return to work — but recent months have given some signs the situation might not be as bad as many have worried.
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10. The Yield Curve Inverts
Most economists will tell you, there might be no sign of a pending recession more reliable than the inversion of the yield curve. Of course, it doesn’t help that they seem to be the only ones who really understand what an “inverted yield curve” actually is, but so it goes.
The yield curve refers to a graph of the interest rates on Treasuries (government debt) of varying lengths. Money lent for longer periods of time normally has a higher rate to reflect the increased risk, so the graph usually slopes from lower rates for the short-term debt to higher rates for the long-term debt.
However, the value of long-term bonds increases significantly when either interest rates or the stock markets drop, and because both those things happen simultaneously during a recession, bond traders start scrambling for the long-term debt when they feel a downturn is looming. That increased demand can eventually push the interest rates on long-term debt below short-term debt — “inverting” the yield curve.
Past Recessions and Inverted Yield Curves
While the ins and outs of the market for government debt can be difficult to comprehend to the uninitiated, it plays a huge roll in the American economy. What’s more, the reliability of this particular indicator blows most of the others out of the water in the eyes of most economists.
But, every recession in the past century has seen the yield curve invert prior to the downturn in growth, so this has become one of the more closely watched signs.
The Yield Curve Now
The yield curve is not presently inverted, though it’s pretty close. As of June 25, three-month T-notes had a yield of 0.14% compared to 0.17% on the six- and 12-months, 0.67% on the 10-year T-bills and 1.41% on the 30-year T-bonds. However, while the yield curve isn’t presently inverted, those yields are incredibly low. That does mean that it’s cheap for America to borrow money right now, at just the right time to give Congress the option to spend more to help support the economy and unemployed workers. If inflation remains higher than 0.67% for most of the next decade (probably a safe bet), that would essentially mean that lenders would be paying the United States to borrow their money.
No One Sign Is Perfect
More than anything else, the best thing to remember about the chance of a recession at any given point in time is that it’s inevitable. Sooner or later, the good times give way to the bad, as they always have. And while there are warning signs, no one has really ever perfected timing the market. Just look at how the beginning of this year unfolded. For all of the careful examination of these different factors over the course of years, it was something entirely unpredictable that finally tipped the long recovery back into the negative.
So while it’s one thing to note the inversion of the yield curve and start sticking a little more in your savings account each month, doing something like selling off all your stock investments trying to avoid the next downturn is probably going to be more trouble than it’s worth.
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Andrew DePietro contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: 10 Recession Red Flags — How Many Did You Miss This Year?
