Are We Headed for a Recession? Here's What the Indicators Are Telling Us

The economy is a hot topic of discussion these days, with many wondering whether we are headed towards a recession. The last few years have seen an extended period of economic growth, but experts are warning that this could be coming to an end. So, are we headed for a recession? Here are some of the warning signs and indicators that are pointing towards a potential economic downturn.

Lagging vs. leading indicators

Economic indicators fall into two categories: leading and lagging. Lagging indicators, such as interest rates, the unemployment rate, and inflation rate serve as evidence of what has already happened within the economy. These can be compared to what you see in a car's rear view mirror.

Leading indicators, on the other hand, are trends and patterns that precede economic shifts. They are used to predict the future performance of the economy, such as stock market trends and consumer confidence. They are similar to signs that you see on the road up ahead.

While lagging indicators provide insight into what has already occurred, leading indicators are often more useful for investors and policymakers alike because they provide insight into what may come in the future. Here are common leading indicators and what they are currently saying.

Yield curve inversion

One of the major indicators that experts consider when trying to predict a recession is the shape of the yield curve. The yield curve is a graph that shows the interest rates of bonds of different maturities.

In a normal yield curve, longer-term bonds have higher interest rates than shorter-term bonds. However, when the opposite happens, and shorter-term bonds have higher interest rates than longer-term bonds, this is called a yield curve inversion.

An inverted yield curve has virtually preceded every recession since 1950, making it a reliable signal that we could be headed for a downturn. The yield curve inverted in 2022 and has widened in 2023. As of July 6, 2023, the yield on the three-month Treasury bill was 5.46%, while the two-year Treasury note closed at 4.99%. By comparison, the yield on the much longer-term 10-year U.S. Treasury note was 4.05%.

According to the Federal Reserve, based on the yield curve alone, there is close to a 70% probability that the U.S. will enter a recession in the next 12 months.

Falling consumer confidence

Consumer confidence is another important indicator of economic health. When people are confident about the economy, they are more likely to spend money, which helps to stimulate growth.

However, when confidence falls, people tend to save more and spend less, which can slow down the economy. Consumer confidence has been decreasing steadily in recent months, with concerns about job security and the possibility of a recession being major factors.

According to the recent figures, consumer confidence has improved in June, reaching its highest level since January 2022. However, the expectations gauge continues to signal a recession over "the next 6 to 12 months."

Manufacturing slowdown

The manufacturing sector is another area of concern, as there are signs of a slowdown in activity. Manufacturing is often seen as a bellwether for the economy because it tends to be sensitive to changes in demand.

This is measured through the Institute for Supply Management (ISM) Manufacturing Index. A slowdown in manufacturing can indicate that demand for goods is decreasing, which could lead to a broader economic contraction.

The ISM Manufacturing purchasing managers index (PMI) in the United States fell to 46.0 in June 2023, the lowest level since May 2020. In the past 11 recessions, the index has been between 42.1 and 66.2 the month before the recession started, with an average of 49.7.

Unfortunately, the economy has been below that average for the past eight months. The current level of 46.0 is not good news, as it is lower than nine of the last 12 recessions.

The S&P 500

As one of the world's most important stock market indexes, the S&P 500 acts as a reliable leading indicator for the U.S. economy. This is due to its composition, which is made up of 500 of the largest publicly traded companies in the United States.

By tracking the movement of these companies' stocks, the S&P 500 provides insight into the overall health of the U.S. economy. Investors and analysts alike often look to the S&P 500 for signals on future economic trends.

Year to date, the S&P has performed well, and is up 15.03%. However, it is still down about 8% from its all-time high of 4796.56 on Jan. 3, 2022. The S&P's rally this year is largely due to tech companies riding the AI boom. Without these handful of stocks performing well, the S&P would be negative. The transportation, consumer discretionary, and finance industries are down YTD, signaling a possible recession.

While there is no crystal ball that can predict exactly when a recession will happen, the warning signs are there for those who are paying attention. A yield curve inversion, falling consumer confidence, and a manufacturing slowdown are all indicators that we could be headed for a recession. However, it's important to remember that the economy is cyclical and that downturns are a natural part of the economic cycle. By keeping on top of your personal finances and staying informed about the state of the economy, you can weather any economic storm that may come your way.