Investor beware? Learn all about a down market with our recession survival guide.
Are we in a recession?
It's the question on every media talking head's lips, and every investor's mind. Discussions involving the "R" word are practically inevitable when the economy faces a popped bubble. While the question lacks a definitive answer, certain signs do signal that we're headed into a downturn.
As a rule of thumb, a recession involves at least two consecutive quarters of negative real GDP. According to FXStreet.com, the National Bureau of Economic Research (NBER), the official judge of when recessions begin and end, has broadened its characterization to consider four indicators: industrial production, payroll employment, inflation-adjusted personal income, and the volume of sales of the manufacturing and trade sectors.
Unfortunately, these are lagging indicators, taking a full six months to get recognized and announced by the NBER. Since recessions typically last six to 18 months, the recession could potentially be over by time the announcement is made. So how can we at least speculate that we're in a recession while we are in it?
Searching the Internet for the word "recession" can leave your head spinning, as economists deliberate which signs truly reveal that our economy has started slumping. But we've culled all that information down to the best of our Foolish abilities, and we've come up with these four key indicators investors can use to figure out when a recession has arrived.
Slower consumer spending
The collapse of overvalued assets of any form -- such as housing -- can trigger a recession. As consumers watch the values of their inflated assets evaporate, they're less likely (or able) to spend money, because they don't feel wealthy. Thus, watching consumer spending habits can be a great warning sign.
These days, investors tend to emphasize the monthly same-store sales performance of big-box retailers such as Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). But keeping a close eye on higher-end consumer-goods companies that typically display strong growth, such as Nordstrom (NYSE: JWN) and Apple (Nasdaq: AAPL), can also be a great indication, should these companies begin to display weakness. Company conference calls in consumer-facing industries will also start attributing weaker performance to lighter customer spending. And with 70% of the U.S. GDP relying on consumer spending, according to Morningstar, any cutback can significantly hurt the economy.
Inverted yield curve
Unlike a normal yield curve, which suggests that interest rates will rise in the future, an inverted curve indicates that investors believe rates will drop in the future, since the yield curve parallels interest rates set by the Fed. Expected declines in interest rates demonstrate investors' confidence that the Fed will continue to lower rates to stimulate a deteriorating economy.
Watching the weekly unemployment claim reports is quite important. If people lose their jobs, they won't be able to spend money, leading to suffering businesses and a chain of further problems. And when companies release workers, it suggests that business is slowing or expected to slow, and that not as many employees are needed or are affordable.
When price hikes for goods such as food, gas, and clothing begin to rise faster than wages, it becomes more difficult for consumers to maintain their spending habits, causing business growth to slow. Plus, these escalating prices increase the cost of inputs, thinning margins and profitability at many food establishments like Panera Bread (Nasdaq: PNRA).
Not an exact science
The definition of a recession can vary widely. There are many ways for investors to study the health of the economy; the examples above are simply four of the most prominent ones. Ultimately, a recession occurs when our economy is in a slump, pieces of the economy are flowing in the wrong direction, and people fear for our nation's financial well-being.
Luckily, long-term investors aren't too concerned about recessions, since they offer shares of many robust companies at great prices. Still, it's important to understand when our economy faces a challenging atmosphere. Following these signs can give Foolish investors a good idea of our current spot in the economic cycle.