The Advisor’s Cheat Sheet to Recession Indicators

A recession indicator is less like a precise compass and more like one gauge in a pilot’s cockpit full of maps, instruments, and flashing lights.

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

But that doesn’t mean recessions have to catch advisors and clients by surprise. By following the signs of recessions, advisors can understand the economy’s direction of the economy and chart an appropriate course for clients.

To get 39 charts and graphs showing key market trends, download the full Markets Observer report.

Here are a few of the factors that economists track to understand economic activity.

• Inflation. In an economic expansion, inflation tends to rise. The Federal Reserve may raise interest rates to keep it under control. It’s a tightrope act. The Fed hopes to contain inflation and encourage growth, without tightening monetary policy so much that we tumble into a recession.
• Stock market declines. Economists look at the difference between stock market performance and its peak. A downturn is 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 spreads have predicted recessions, but they can’t pinpoint the exact start date, severity, or duration.
• The inverted yield curve, when short-term bond yields climb above longer-term ones, has historically happened ahead of a recession. It indicates an expectation of lower interest rates, and thus lower growth and inflation, down the road.
• 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 third quarter of 2024. Unlike the previous quarter, small- and mid-cap equities saw gains, showing a broadening of the market expansion. Large-cap stocks saw gains as well, but to a lesser extent.

The third quarter was a turning point for central banks around the globe.

Most central banks have clearly signaled the onset of easing, and many sovereign 10-year yields traded lower after trending higher in the first half of the year. The People’s Bank of China announced a series of stimulus measures, while the Bank of England and European Central Bank both cut rates during the quarter.

Our forecasts for the path of the federal-funds rate are well below market expectations, growing into a nearly 2-percentage-point gap by the end of 2026. Our optimism on inflation coming down is a key reason why we expect interest rates to fall faster than the market.

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 3.0% by 2027, down from 4.1% as of October 2024.

The Federal Reserve changed its course and cut the target range for the short-term federal-funds rate by 0.5% on September 18, 2024. Long-term yields followed short-term yields lower over the quarter, and bond prices increased.

The spread between the 10-year and two-year yields also turned positive, meaning the yield curve isn’t inverted for the first time in over two years.

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

A resilient economy has provided a tailwind for corporate bonds, but weakening corporate fundamentals and the upcoming 2024 US presidential election could all cause future credit market volatility.

We expect US GDP growth to slow over the next year, owing to depleted household savings and other factors.

The alleviation of supply constraints along with cooling demand is pushing inflation down, and we expect inflation about in line with the Federal Reserve’s 2% target in 2025 and beyond. This should allow the Fed to cut rates aggressively, triggering a GDP growth rebound in 2026 and following years.

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.

Inflation should continue to normalize as supply disruptions are resolved and demand cools off. China could also transmit its low inflation to the rest of the world via expanded exports, but this could run afoul of protectionist backlash.

After a dip in 2022, housing price growth has been strong since mid-2023, and it stands at 6% year over year as of second-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.

Low tariff rates have been the norm for the United States and most other major economies since the end of World War II, but that hasn’t always been the case. From the second half of the 19th century to the early 20th, the US had very restrictive tariffs.

One key lesson is that high tariffs, once they’re in place, are very hard to dislodge, owing to vested interests and the need for unified control over government.

In contrast to most issues, US presidents can enact sweeping changes on trade without congressional approval. We estimate that Donald Trump’s proposed tariff hikes would subtract 1.9% 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 0.13%.

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 have them sign it to commit to the plan.