Is it Time to Prepare for a Recession?

Although several years have passed since the catastrophic financial downturn, our most recent recession is still on business owners’ and economic analysts’ minds, prompting some to ask whether we are headed for similar conditions.

Understanding the signs and symptoms of a recession offers clues about what the future may hold, potentially alerting you to prepare your business for an inevitable downturn. Is the current US economy a harbinger of negative things to come? Or will the brisk economy continue in the right direction, without cause for concern?

What Are the Warning Signs?

According to the International Monetary Fund, there is no precise definition of a recession. Instead, analysts and economic stakeholders rely on a set of symptoms to evaluate the potential for a downturn. In general, a recession refers to a period of decline in economic activity; additional identifiable conditions reinforce the diagnosis.

A short period of declining economic activity is not considered a recession. One widely accepted practical definition requires at least two consecutive quarters of decline in a country’s GDP to reach the threshold of a recession. Although it provides a useful starting point for economic analysis, focusing solely on the two-quarter rule has drawbacks. The singular focus offers insight, but considering a wider set of measures may provide better indicators a country is on the verge of a recession.

The National Bureau of Economic Research (NBER) adopts a broader definition of recession, using a number of distinct measures to identify the beginning and ending dates of a true recession. According to the private organization, a recession is defined 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. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.”

In line with the NBER definition, a recent article described a number of accepted characteristics of a recession, such as:

• Economic activities decline
• Credit is harder to obtain
• Wage growth slows
• Unemployment rises
• Economies collapse
• Business contracts

In addition to exhibiting these indicators, history shows recession often takes hold before observers reach consensus about the condition, and that once it begins, a recession quickly gains momentum.

Is the US Heading Toward a Recession?

Among the variables influencing economic recession, accounting for a time element may provide clues about the future of an economy. If you believe economic health ebbs and flows in a regular cycle, we may indeed be in store for a slowdown.

The US is presently experiencing the longest sustained period of economic expansion in the country’s history. Economic expansion is the antithesis of recession. In a predictable cycle, balancing the two extremes, the upside of expansion is naturally followed by a period of recession. If considering only the time element, analysts point to the liklihood of a pending slowdown. However, time isn’t the only consideration when forecasting economic outcomes. According to Forbes, the robust period of expansion isn’t predetermined to come to an end, nor is a recession the only follow-up to a lengthy phase of expansion.

In addition to accounting for time when assessing the potential for a near-term recession, economic analysts also evaluate the following aspects of the economy, among others.

• Unemployment Rate – Unemployment is a valuable metric, because the numbers reflect economic deterioration in nearly real time. The present unemployment rate, hovering near 3.6% is historically low. One method of analysis, the Sahm indicator, relies on an unemployment spike of .50 as a predictive change, ahead of a recession. The indicator presently remains low, at .07, well below the threshold thought to foretell a recession.
• Consumer Sentiment – Consumer behavior is an important metric, because slowed spending constricts expansion. The Consumer Confidence Survey is used to assess consumer sentiment. It is thought a 15-percent drop in consumer confidence somewhat reliably indicates potential for dropping in to a recession. Confidence currently remains high, with no sign of a 15-percent drop on the horizon.
• Manufacturing – Often used to measure overall economic health, manufacturing is showing signs of contraction. The Institute for Supply Management (ISM) surveys major manufacturers about various aspects of their businesses, including production, inventories, deliveries, and more. An index derived from survey results is thought to exhibit growth when readings exceed 50, while it is believed readings below 50 may indicate potential for recession. At 48.3 the present reading isn’t catastrophic, but may be a sign of business contraction.
• Yield Curve – When used to predict recessions, yield curve refers to the relationship between the 10-year treasury bond and the 2-year treasury bond. When the economy is expanding, the 10-year bond has a higher interest rate than the 2-year bond. Under certain conditions, when the 2-year bond has a higher interest rate than the 10-year bond, the curve inverts. The yield curve inverted in August, and analysts aptly point out that the last time this occurred, in December 2005, a recession was not long to follow.

Predicting a recession is not an exact science. Though the US economy continues extending a period of expansion, some economic indicators support the potential for a recession. With the jury still out, small business owners are advised to watch out for three symptoms of a serious slowdown. In particular declining economic activity, rising unemployment, and reduced credit availability may be the writing on the wall for entrepreneurs attempting to identify pre-recession conditions.