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June 30, 2023

How to spot the warning signs of a recession

Your investment strategy isn’t just about the accumulation of money. It’s about preparing yourself for the future and reading the market. It’s also about understanding and identifying the risks.

You might face considerable losses during a recession if you have a significant stake in the stock market, real estate, or other investments. Not only because your assets could lose value, but you may need specialized advice to protect your assets against market volatility. That’s why it is critical that you understand the warning signs when a recession hits.

Let’s define a recession and look at the economic indicators telling you that the next one might be around the corner.

What is a recession?

Even if some newspaper headlines would like to make you believe otherwise—recessions are inevitable. At least, that’s what most modern economists agree upon, and the numbers also confirm that.

The Great Recession is often overlooked, but the impact of past crises like the mortgage crisis and dot-com bubble cannot be forgotten. COVID-19 is just the latest addition to a long list of economic challenges. The International Monetary Fund (IMF) confirms that we faced 122 recessions between 1960 and 2007.

Recessions aren’t uncommon, and neither is the inflation that often follows them. They’re a normal part of the capitalist economy, so indicators like an inverted yield curve and economic activity can predict them. But what causes them in the first place?

As everything in a realm ruled by numbers, a recession is largely defined by markers. Most commonly, economists use one or several of these recession indicators:

  • Gross domestic product (GDP)
  • High inflation 
  • Industrial production
  • Labor market
  • Retail sales
  • Trade

Sometimes, what economists consider a recession can also be determined by the decline’s duration or cause. You’ll often hear experts speculating about the next quarter because two-quarters of negative GDP in a row is often considered a recession instead of a downward trend.

They also theorize that it’s human nature to ask how long each recession might last and when we can expect an upward trend again. The objective answer to this question is straightforward: The IMF states that the typical recession lasts roughly a year.

Even months after the market has bounced back, many workers might still be unemployed. So, how long a recession will personally impact you depends mainly on your profession and financial situation.

A recession can especially influence our short-term goals. Having stable and consistent plans for your assets is crucial before the surf hits the rock. Marsh McLennan Agency offers individual solutions for asset management and employer retirement planning that already factor in the dangers of a recession.

Recognizing the signs of a future recession

You don’t want a recession to catch you off guard, so know what red flags to pay attention to. While unemployment might affect you personally, it’s also one of the reliable indicators of a future recession. Mass layoffs in certain industries or increased unemployment may signify a recession.

We’ve covered declining GDP growth, falling industrial production, and trade. Here are some additional markers to watch out for:

  • Inverted yield curve: The yield curve shows if bond investors prefer short-term or long-term debt. When it’s inverted, it could mean they prefer long-term investments because of market expectations.
  • Stock market decline: The stock market goes up and down every day, but if the S&P 500 or Dow Jones Industrial Average (DJIA) drops a lot, it means investors are worried about the future of the market.
  • Tightening credit markets: When there’s not enough money to lend, it could mean a recession is coming. It might be harder to get a loan, or the interest rates might be too high for people to afford.
  • Decreasing housing prices: When home prices go down, it could be a sign that the economy is getting worse. This often happens in places where people build too many houses or buy and sell houses too much. It can also affect the credit market.

If you want to be certain, you can always rely on economists. The Business Cycle Dating Committee of the National Bureau of Economic Research typically determines the start and end dates of each recession. But that doesn’t mean you can’t do your own research.

How does a recession affect the economy?

Every recession is slightly different in how it affects the overall economy. The COVID-19 recession impacted the entire world’s economy, whereas the dot-com bubble mostly affected the tech industry and those associated with it. 

That’s not to say that one is better than the other, especially considering technology’s important role in our lives. Still, it shows that each recession will affect everyone differently.

During a recession, investment returns, housing prices, the labor market, and tax revenues decrease while interest rates and inflation rise. The Federal Reserve can help mitigate the effects by shaping monetary policy. The impact can vary across industries and regions, with each recession being unique.

It’s good to remind yourself that this is a cycle, and this pattern is a normal part of conducting business. So even if the headlines may currently suggest otherwise, a sound investment today will protect you from market volatility tomorrow.

How to financially protect yourself against a recession

Whether a business owner or a private investor, you can take several steps to financially guard yourself against the next recession. Good financial habits are important for managing money. Depending on how much risk you’re comfortable with, different solutions can be helpful.

  • Build up your emergency fund: Having an emergency fund for your business during uncertain economic times is crucial. It should cover all expenses for at least three to six months, giving you time to make informed decisions.
  • Pay down debt: As credit card debt continues to rise, it can create financial pressure even in a robust economy. Prioritizing the repayment of high-interest debt can provide greater financial leeway, especially during periods of job transitions or other outstanding loan obligations.
  • Consider alternative income streams: If the job market is unstable, having a variety of investments can help. Also, starting a side business can give you more money when you’re not working and help make your family more financially stable.

A recession can throw a lot at you all at once, so it’s best to guard yourself against it before everything comes crashing down.

If you’d like to learn more about how to protect yourself against the next recession, get in touch with our practiced specialists. We’re happy to help you with everything from business insurance to retirement and employee benefits.