To make sound financial decisions, it’s important to understand where we are in the business cycle (expansion, peak, contraction which could turn into a recession, and trough), how well the economy is doing, and where the economy might be headed.
Let’s start with the basics.
First, what is a recession?
A recession is typically defined as two consecutive quarters of negative economic growth, as measured by a country’s gross domestic product (GDP). While GDP is the most common way to measure a recession, others include higher unemployment rates, and lower stock market prices. In short, it’s when the economy as a whole slows down.
Recessions can be caused by various factors, including tight monetary policy, high-interest rates, a housing market crash, an oil price shock, or even a war.
How likely is it that the U.S. will have a recession?
Let’s look at some of the indicators that drive the economy. We’ll break this down into two separate sections and give you an overview of both.
Economic indicators – economic statistics like unemployment rate, GDP, or the inflation rate that suggests how well the economy is doing now and how well it might be doing in the future.
Pro-cyclic indicators – are economic indicators that move in the same direction as the economy. This means that if the economy is doing well, these number typically increases. If we are in a recession, these numbers typically decrease.
Examples: retail sales, industrial production, new orders for durable goods (like appliances), number of employees on nonagricultural payrolls, and GDP
Leading economic indicators are economic statistics that change before the economy changes. In this way they help predict how the economy will do in the future. Examples of this include the stock market, the number of new building permits, and the consumer confidence index.
Let’s take a look at some of these things in depth.
How are consumers spending?
When consumers have less to spend (or spend less because of job losses or economic insecurity), they cutback. The problem with that? Declining consumer spending undermines the prospects for recovery.
But only a smaller portion of our economy is cutting back.
Because inflation is running so high, the Fed is having to hike interest rates to levels that haven’t been seen since 2009. April 2021, the average home loan rate was below 3%. Today, it’s at 5.25%.
While this hits people looking to purchase a home, rising interest rates also impacts businesses.
How do interest rates increase the risk of recession?
Just like lower consumer spending can hit the economy, so can lower business spending. When borrowing costs for businesses rise, companies slow how much they purchase, avoid expanding capacity and also reduce hiring. This (combined with wage growth as a result inflation) could lead to layoffs.
With the nation’s unemployment rate at a 50 year low of 3.6% and with companies posting record-high open jobs, how could we still be at risk of a recession? According to the experts, an increase in the unemployment rate of .3% on average over three previous months has meant a recession will follow.
We’re not there yet. So what are we seeing?
Falling Stock/Commodities Prices
On May 9, 2022, tech stocks like Apple (-3.3%) and Amazon (-5.5%) were down. Boeing was down 10.5%. With Bitcoin dropping 8% and the total crypto market cap sinking over 10%, not even cryptocurrency gave investors a respite from the sinking markets.
But things are always changing. In order to stay up to date, and assess how likely we are headed for a recession look out for these other indicators:
GDP and jobs
Pro-cyclic stats like inflation and interests rates
Counter-cyclic states like unemployment (or even gold prices)
Consumer confidence index
Interest rates including the federal funds rate
Also, be prepared. A recession can have a major impact on your finances. If you are not prepared, you may find yourself in debt or even unemployed.
Here are some tips to help you prepare for a recession:
1. Build up an emergency fund. Ideally, an emergency fund has 3-6 months of savings. In reality, most households are unable to save more than a month or two. In just three weeks, nearly 17 million Americans filed for unemployment due to the financial crisis brought on by Covid-19. An emergency fund will give you money to live on if you lose your job or have unexpected expenses.(And a crisis budget can help you stretch your cash.)
2. Pay off your debt. This will reduce your monthly expenses and give you more financial flexibility. As PennyUpgrade points out “Our first step[to tackling debt] was to actually find a way to track it. After stumbling onto a financial management app, we learned our most valuable lesson, “give every dollar a job”. We made categories for every single expense we had and tracked every dollar. By doing this, we were able to have a clear picture of our finances and where we were spending our money. After a while, it becomes a lot easier to see where you can cut spending.”
3. Invest in yourself. Recession-proof your career by taking courses, learning new skills, or networking. There are a number of free or cheap ways to learn new skills to develop professionally throughout your career without the help of your employer or company.
4. Live below your means. It’s a little easier to be less financially stressed when you have more money to spend. Make sure you understand where you are, how much income you have coming in, and that you have enough to cover your expenses. Basic steps to money management will help you save money and stress less.
5. Stay diversified. Don’t put all of your eggs in one basket. This means that if you jumped on the crypto bandwagon, but didn’t invest in the S&P500, now might be a good time to diversify your assets. This helps protect yourself from the impact of a recession.
While the United States has experienced a number of recessions over the past few decades, there are ways to limit the impact a recession can have on your finances. Save money ahead of time to help cushion the blow if you lose your job, or invest in recession-proof stocks.
By following these tips, you can help protect yourself from the financial impact of a recession.