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Is a Recession Coming?


Why It Is Time To Ask: Is a Recession Coming?

With the United States economy in the sixth year of economic expansion, it is a good time to ask whether there is a recession coming in the not too distant future. The average recovery since World War 2 has been approximately six years, so based on this average alone, it is time to question whether a recession is looming. Of course, economic circumstances change over time, so each economic expansion is not exactly the same. During recent economic expansions, it appears that the unprecedented Federal Reserve intervention in the United States economy has caused economic recoveries to last longer than they have in the past.

Instead of relying solely on historical trends, it is useful to look at economic indicators to gauge whether a recession is coming in the near future. A look at the current snapshot of economic indicators that track whether a recession is approaching provides some useful clues regarding where we are at in the current economic cycle and whether a recession may be approaching. This is important information for both stock market traders and investors to understand, since a recession is usually accompanied by a stock market decline, which can be quite significant. There are even ways that money can be made during a recession and stock market decline.

Is a Recession Coming | A Look at a Reliable Indicator

One of the most reliable recession indicators is iM’s Business Cycle Index. While this index is currently in an upward trend and does not indicate an impending recession, it does provide some interesting clues for traders and investors that want to get ahead of the recession curve and know when the next recession will hit the economy. As of late April, the weekly Business Cycle Index is at a level of 193.0. The six-month smoothed out annualized growth Business Cycle Index is at 19.2. Both of these readings are healthy and their upward trend is in line with economic reports that indicate that the economy is expanding. See the image on the right for a graphic depiction of where the two Business Cycle Index readings are in comparison to the past two decades.


What is interesting about the Business Cycle Index numbers is that they are now approaching the levels that they were at during 2008, when the economy last peaked and headed into a recession.   That recession was quite severe and resulted in a sizable bear market sell-off. Anyone who was able to get an early warning of the pending recession and make adjustments to their investment portfolio was well served by following this indicator. As you can see from the image to the right, the two Business Cycle Index readings both provided warnings of pending recessions a few months before they happened.   They peaked and then started heading down before the economy started contracting, providing traders and investors time to adjust their investment portfolios for the impending stock market sell-off. The key is take action when the two Business Cycle Index readings top out and start heading down. This occurs just before a recession occurs.

Is a Recession Coming | A Look at Other Recession Indicators

Of course, it is a good idea to look at other recession indicators for confirmation that a recession may be approaching. There are four big economic indicators that economists use to identify the state of the economic cycle and whether a recession is approaching. They include: Industrial Production, Real Personal Income, Nonfarm Employment, and Real Retail Sales.   The reason why these four indicators are utilized to gauge whether a recession is coming is because they tend to provide a good snapshot of where the economy is heading.

Real Personal Income and Real Retail Sales are the best two indicators to focus on, since the United States economy is comprised of a 70% contribution from consumer spending. Without rising Real Personal Income and Real Retail Sales, the economy has a hard time growing.

Industrial Production should be looked at with a longer view over a number of months, since it can be a choppy indicator that can provide false positives and negatives when viewed during a short period of time. Nonfarm Employment can be misleading, since it is not all that uncommon for employment to keep growing due on momentum, even as the overall economy is slowing. But taken into consideration with Real Personal Income and Real Retail Sales, both the Industrial Production indicator and the Nonfarm Employment indicator can provide valuable clues regarding the direction the economy is moving and whether a recession is on the way.

How To Trade and Invest When a Recession Is Coming

Recession AheadChance are that if the economy goes into recession that the stock market is going to sell-off. Stocks ultimately obtain their value from earnings, and earnings fall during times of economic contraction. This causes the stock market to sell-off during the first part of a recession. Sometimes the sell-off in stocks is steep, exceeding 20% or more. This provides an excellent buying opportunity for long-term investors and a good trading opportunity for stock traders.

There are a couple of important things to remember when investing or trading directly before and during an economic recession.   First off, any steep sell-off that materializes could take several months to materialize. If you see a recession coming, and indictors continue to indicate that a recession is on its way or has commenced, it may be time to trim your stock holdings. Sometimes it takes a few months for the stock market to respond to lower earnings and other bad news associated with a recession. Second, if you are looking to buy stocks at the depths of a recession, buy towards the middle of the recession, when economic indicators stop falling and the recession is at its worst depths. The stock market is notorious for rallying sharply coming out of a recession, in anticipation of better economic times ahead.   The stock market will move higher long before a recession is over.

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