It's hard to believe that just five and a half years ago, the U.S stock markets were hitting their trough, with the Dow Jones Industrial Average and S&P 500 losing over half of their value in a span of less than two years. Since that bottom, and the end to the worst recession the United States has seen in seven decades, the Dow has soared more than 10,000 points, and the S&P 500 has tripled -- not a bad return for investors who stayed the course.
Of course, just as expansion is a normal component of the economic cycle, so are recessions. Over the past 70 years the U.S. economy has dipped into 12 separate recessions, with most lasting no more than a couple of quarters. Meanwhile, the Great Recession lasted from December 2007 until June 2009, brought U.S. unemployment to its highest rate since the early 1980s, and reduced U.S. GDP by the largest amount since the recession of 1945.
From an individual financial perspective, the Great Recession was just as brutal. Federal Reserve data released in 2012 showed that median family net worth plunged 39% to just $77,300 between 2007 and 2010, placing families on par with their net worth of 1992! We've come a long way since those 2010 figures, but we will inevitably witness another recession in the U.S. at some point in the future.
The two most important things you need to know
As an investor, there are two important things you must realize about recessions. First, investing for the long term is still your smartest move: Trying to time the market is generally a fruitless venture, and sticking to the sidelines can lead you to miss out on the subsequent rebound in the stock market and the economy.
Secondly, realize that you'll never know with any certainty what will cause the next recession. Sometimes the clues may seem obvious, but ultimately, something completely off investors' radars could end up sending the U.S. economy into a spiral.
Five events that may cause the next Great Recession
But just because we'll never be able to pinpoint the next recession-causing event with 100% certainty doesn't mean we shouldn't stay on top of the macroeconomic events that could adversely affect the U.S. economy.
With that in mind, I'll offer my guess as to what five events are most likely to be responsible for the next Great Recession.
1. The China housing bubble bursts
It's tough to envision China being the source of a global recession, considering that it was perhaps the lone bright spot during the global recession a few years ago. However, certain aspects of its housing sector lead me to believe that it could be a ticking time bomb.
Real estate investments in China account for a shockingly large 16% to 20% of its GDP, according to Bloomberg. This equates to between $1.48 trillion and $1.85 trillion based on China's $9.24 trillion in 2013 GDP. As we were reminded just a few short years ago in the U.S., a primary residence is, well, a place to reside -- not something to invest in.
Lately, the growth rate of real-estate investment and home prices has been dropping rapidly. Real estate development growth was down to 13.7% in June-July from 19.8% in December 2013-January 2014, while home prices continue to lose momentum, rising just 2.5% year over year in July compared to 9.9% year-over-year growth in December.
As if this were not enough to worry investors, builders in Guangzhou and Shenzhen, which are dealing with suddenly reduced investment interest, have been pushing no-money-down purchases on homes despite government regulations that require 30% down.
This whole situation looks eerily similar to the U.S. housing bubble collapse, if you ask me.
2. Commodity spot prices plunge
With the exception of 2013, gold and its other precious-metal peers have been practically unstoppable for more than a decade. More importantly, rising prices for gold, silver, oil, iron ore, etc., act as a stabilizing factor for emerging-market economies that are rich in natural resources, granting them the cash flow necessary to build out their infrastructure and develop into industrialized nations.
Unfortunately, we're beginning to see what might be the beginning of a serious decline in commodity prices. Specifically, I worry about gold, given that QE3 is expected to end later this year. With the Federal Reserve no longer expected to inject billions into the U.S. economy on a monthly basis, the idea that a rapidly expanding money supply will lead to inflation practically goes out the window.
With the gold hedge bet off the table, there may be little left to support gold and other commodities used to hedge for inflation. If these spot prices fall, a number of emerging markets around the world could feel the pain. Eventually this weakness would ripple to the U.S., likely in the form of weaker export demand.
3. A major industrialized nation goes to war
For a select few countries, a war can actually be a boon. But on a broader scale, war is rarely a good thing for the global economy, as it brings into question a number of uncertainties -- and, put plainly, Wall Street hates uncertainty.
Take Russia's ongoing spat with Ukraine as a good example. Though most multinational U.S. companies only receive a small portion of their revenue from Russia, the implications of a war between Russia and Ukraine would be far-reaching. The price of oil would likely rise, as Russia could choose to simply stop supplying the rest of the world with energy assets. Global trade would likely also take a hit: Regions like Europe would struggle, as Russia is an important trading partner for the region. As allies take sides with one another, global trade could suffer, pushing the U.S. and global economy into a recession.
4. U.S. subprime auto loans implode
As if U.S. lenders didn't learn their lesson in 2008, we appear to be on the precipice of another potential credit bubble -- except this time it's for auto loans.
Based on figures from Experian, the total number of subprime loans -- i.e., loans written to people who have undesirable credit scores and/or may have difficulty securing a loan -- in the first quarter of 2014 rose 15% to a whopping $145.6 billion. Credit agency Equifax says subprime auto loans constituted 27% of all auto loans written in 2013 compared to just 20% in 2009.
As an investigative report from The New York Times recently discovered, subprime loans can occasionally peak at lending rates of more than 23%, and these loans can be more than double the actual value of the car after interest is paid. Furthermore, when the car needs repairs, subprime borrowers often struggle to continue making their payments. The New York Times concluded that subprime loans can "thrust already vulnerable borrowers further into debt, even propelling some into bankruptcy."
While it should be noted that the magnitude of outstanding subprime car loans is nowhere near the size of the subprime mortgage loans that crushed the U.S. economy, they could still pack a big enough punch to sting U.S. lenders and potentially hurl the U.S. economy into a recession.
5. The U.S. Highway Trust Fund runs out of reserves
Finally, I'd suggest investors watch our nation's infrastructure sector for warning signs.
This past week we examined the health of the Highway Trust Fund -- which is responsible for divvying out funds used to maintain and build our nation's roadways, bridges, and even some aspects of energy infrastructure -- and determined it's nothing short of a mess.
The Fund began the year with $10.4 billion after it transferred some money over from the General Fund. However, prior to a congressional vote in July that extended funding through May 2015, the Highway Trust Fund was projected to run dry as soon as this month.
Congress' inability to come together has been a problem on a number of social issues, but kicking the can down the road with the Highway Trust Fund simply won't work as a long-term solution. The reason is that more than 14 million people, or 10% of the U.S. labor force, work in some form of infrastructure job. With about $1 billion being funneled from the fund to contractors on a weekly basis, a reduction in funding could lead to a rapid rise in unemployment across states that haven't aggressively implemented tax hikes to make up for the revenue reimbursement shortfall.
Of the five potential threats outlined here, this one is probably least likely to trigger a recession, but the threat is more real than you may think.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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