Recession Indicators: The Financial Advisor’s Cheat Sheet

Economists often use imperfect historical information to form opinions about the economy’s direction. We often don’t know we’re in a recession until it’s well underway—typically, the National Bureau of Economic Research adjusts a recession’s start date after the fact.

However, that doesn’t mean recessions have to catch advisors and clients by surprise. By monitoring potential signs of a recession, advisors can understand the direction of the economy and chart an appropriate course for their clients.

Here’s what Morningstar evaluates and where indicators stand. To get 52 pages’ worth of charts and graphs showing key market trends, download the full Markets Observer report.

Here are a few signals that economists track to understand economic activity.

• Inflation. In an economic expansion, inflation tends to rise. This may cause the Federal Reserve to raise interest rates enough to contain inflation and encourage growth, but not enough to trigger a recession.
• Stock market declines. Economists look at the difference between stock market performance and its peak to evaluate potential recession conditions. A downturn is defined as a stock market decline from its peak by 20% or more.
• Credit spreads show the yield difference between two fixed-income investments with the same maturity but different credit qualities. In the past, negative credit spreads have predicted recessions, but they can’t pinpoint the exact start date, severity, or duration.
• The inverted yield curve refers to when short-term bond yields climb above longer-term ones. This indicates an expectation of lower interest rates, and thus lower growth and inflation, down the road. Inverted yield curves have also historically occurred ahead of a recession.
• Decrease in real GDP. Consumers tend to tighten their belts in response to economic uncertainty. That could lead to lower economic output, layoffs, and economic contraction.
• High unemployment. Recessions tend to stifle wage increases and promotions. Factors like job sentiment, wage growth, and initial jobless claims can be signs of a recession.
• Business spending, which includes business investment, housing, and inventories, has often declined, on an annual basis only, at the start of a recession.
• Price of gold. When investors anticipate an economic downturn, they tend to flock to gold as a store of value.
• New housing starts and home prices. In a recession, home sales often decrease, which can lead to a decline in housing prices. But a recession isn’t the sole cause.

After fully recovering from a late 2023 downturn, the US market expanded further in the fourth quarter of 2024. Unlike the previous quarter, large-cap and mid-cap growth stocks led a narrow expansion. This marks a full year of market expansion since the previous downturn and recovery.

The chart below compares the downturns, recoveries, and expansions with recessions, the latter based on National Bureau of Economic Research data.

Most central banks have signaled the onset of easing, but many sovereign 10-year yields—including the United States, United Kingdom, and Japan—traded higher during 2024’s fourth quarter.

China was an exception, with its 10-year bonds falling to a record low in the fourth quarter. The country’s economic slowdown dominated headlines in 2024.

Our forecasts for the federal-funds rate are well below market expectations, growing into a nearly 2-percentage-point gap by early 2027. Our optimism on inflation coming down is a key reason why we expect interest rates to fall faster than the market does.

Also, we disagree with the emerging view that the neutral rate of interest has jumped compared with its prepandemic level. We expect the 10-year Treasury yield to reach 3.25% by 2027, down from 4.6% as of January 2025.

While the Federal Reserve cut its short-term federal-funds rate by 25 basis points in November and December 2024, Treasury yields rose across much of the yield curve during the fourth quarter. The 10-year Treasury yield, which began 2024 at 3.9%, finished the year at 4.6% as stronger-than-expected economic data increased investor optimism about the US economy.

Corporate credit spreads can indicate the broader economy’s health and investor confidence in credit markets. They remained at historically tight levels during 2024’s fourth quarter, suggesting rich valuations.

Spreads pushed even tighter in the fourth-quarter of 2024 on the back of stronger-than-expected economic data and the market’s reaction to the incoming US presidential administration’s policies and growth agenda, which could provide tailwinds for credit markets going forward.

Credit spreads appear narrow even compared with past soft-landing episodes. Historically, spreads don’t contract much during easing cycles when markets price in a soft landing. However, they could widen significantly in the event of a hard landing.

As a result, today’s tight spreads highlight the asymmetric range of potential outcomes.

We expect US gross domestic product growth to slow over the next year, owing to depleted household savings and other factors. The alleviation of supply constraints and cooling demand are pushing inflation down.

We expect inflation about in line with the Federal Reserve’s 2% target in 2025 and beyond. This should allow the Fed to continue to cut rates, triggering a GDP growth rebound in 2027 and following years.

However, higher tariffs could reduce US real gross domestic product. US presidents can enact sweeping changes on trade without congressional approval, in contrast to most issues. We estimate that Donald Trump’s proposed tariff hikes would subtract 1.90% from the long-run level of US real GDP.

Still, we think it’s more likely than not that Trump would back down from the threatened tariffs, particularly the 10% uniform hike. This leads to a probability-weighted impact of negative 0.32%.

Core inflation for most major economies has receded greatly after peaking in 2022. We’re not quite at the point to declare “mission accomplished” in the battle against high inflation, but it’s very close.

Eventually, China could transmit its low inflation to the rest of the world via expanded exports, though this is likely to run afoul of protectionist backlash. Alternatively, US tariff hikes could cause new inflation pressures to emerge.

After a dip in 2022, housing price growth has been strong since mid-2023, and it stands at 4.3% year over year as of third-quarter 2024. Geographically, the gains are fairly broad-based. Price growth has been weaker in Texas markets, where supply is beginning to overtake demand, thanks to vigorous building.

Diversified portfolios should help clients reach their long-term goals and withstand downturns in the meantime. That perspective isn’t always reassuring for clients worried about a recession.

Our behavioral finance researchers created a checklist for guiding clients through a recession.

• Be the go-to source for advice. Create content to answer common client questions in simple terms. Then share through meetings, emails, and social media.
• Gauge client expectations. Remind overly optimistic clients that market downturns are inevitable and unrealistic expectations could lead to panic. Remind pessimistic clients about the value of staying the course.
• Create concrete action plans. Ask clients to identify triggers that might cause them to tinker with portfolios. Ask them to create an “If, then” list to identify what to do if those triggers happen, then sign it to commit to the plan.