How to Accurately Predict When the Next Recession Will Occur
Timing is everything. Individuals have made fortunes and lost fortunes in response to the timing of their investments. Yale economist, Irving Fisher, famously stated two days before the stock market crash in October 1929, which ushered in the beginning of the Great Depression that “stock prices have reached what looks like a permanently high plateau.” Students of history may know that stocks crashed 13% on October 28, 1929, known as “Black Monday,” dropped 11.91% for the year and continued to slide over the next three years. The cumulative loss was roughly 90%, which wiped out most Americans, including Irving Fisher, who reportedly died broke. It took 25 years for the Dow Jones Industrial Average “Dow” to recover from the market crash.
On the other hand, Jim Rogers and George Soros in 1992 accurately predicted the crash of the British pound and shorted the currency making over $1 billion in a single month. There are countless other stories of investing successes and failures, but that doesn’t necessarily help the average investor, who is doing his or her best to try and build wealth during strong markets and protect their assets during bear markets.
While the S&P 500 has returned approximately 7% in inflation-adjusted returns over the long-term, the average investor has returned about half this amount, if not less due to poor market timing and a fear of missing out (FOMO). Human nature is to buy an asset on the way up or when it has peaked and is making headline news and to panic sell once it drops in value or has hit rock bottom.
Many of our customers are interested in knowing when the stock market will sell off and we’ll likely enter into the next recession. Afterall, it’s been approximately 14 years since the last recession ended. You might make the case that we had a mini recession in 2020 at the start of Covid, but if it started in March of 2020 and ended in April of 2020, it can hardly be termed a recession. Considering that recessions occur, on average, every 6 to 7 years, it appears as though we’re well overdue.
The Yield Curve
Historically, one of the most accurate indicators of an impending recession is the yield curve. For those of our readers who are unfamiliar with the term, it is usually expressed as a chart that plots interest rates over time.
For example, it may start with 30-day Treasury bills and end with 30 year bonds. In a normal and healthy environment, the yield or interest rate on longer-term bonds is higher than shorter-term bills or notes. This intuitively makes sense, as you’re taking on more market and interest rate risk when holding a bond for 30 years as opposed to 30 days.
Another way to look at it is to consider the time value of money. If you were given the option to receive $1 in interest after a month or .50 of interest after a year, obviously you’d go with the shorter time frame and higher interest rate. As crazy as it sounds, at the moment, you’re able to receive a higher interest rate on a 30-day Treasury bill than a 30 year Treasury bond. You may be thinking that this is clearly a market that isn’t operating efficiently and that it can’t go on forever. If so, you’re correct. It can’t.
When plotting the interest rates offered on various term bills, notes and bonds, at the moment, the interest rate is greater on the shorter end of the curve and less on the longer end of the curve or chart. This is what is referred to as an inverted yield curve. Historically, inverted yield curves “un invert” or correct 12 – 24 months after they’ve inverted. On average, it tends to occur 16 – 18 months after it has inverted. Considering that the yield curve inverted in October 2022, it would not be an unreasonable prediction to assume that it will “un invert” in the first quarter of 2024.
What most people don’t realize is that a recession doesn’t occur when the yield curve inverts, but when it “un inverts.” How accurate of an indicator has this been over time? When we look back over the past 70 years or so (specifically since 1955), we see that it’s a nearly perfect prediction of a future recession, with only one false positive in the mid 1960’s. Furthermore, once the Federal Reserve begins to lower interest rates to fight the effects of the recession, historically, stock prices have pulled back. In other words, stocks don’t always respond positively to lower interest rates – at least initially.
This doesn’t necessarily mean that we can’t have a “black swan” event or a “Black Monday” type of market crash in the meantime, so please don’t assume that you’re insulated from a market correction until the yield curve corrects. These are merely rules of thumb that we recommend paying attention to.
Using the Yield Curve to your Advantage
As an investor, this is information that you might want to pay attention to. How will you know when the yield curve returns to normal? It’s as simple as doing an online search and checking the spread between shorter term notes and longer-term bonds. We suggest paying attention to the spread between two year notes and ten year bonds.
At present, the yield spread is approximately -.47%, which is lower than the -.71% spread last year but is still well off the mark of the historical long-term average of .88%. In other words, in a normal market, you would receive .88% more in interest on a 10-year bond over a 2 year note, but at present, you receive .47% less.
We’re not market timers nor do we advocate market timing, and again, the yield curve isn’t a perfect indicator of future recessions, but it’s about as good of an indicator as you’re going to find. While it’s always difficult to sell when everyone else is buying and buy when everyone else is selling, being a contrarian is really the only way to make money and get ahead. Following the herd mentality will only yield “herd-type” returns, which historically have been less than half of what the market yields.
Having your finger on the pulse of when a recession may occur doesn’t just affect your investment decisions, but also your overall savings and purchasing decisions. If you work in an industry that historically has been hard hit during recessions, now may be the time to cut back on your discretionary spending and increase your savings. You’ve probably heard this recommendation before, but most financial advisors recommend that you have an emergency fund of 3 – 6 months of living expenses.
On the other hand, if you’re considering purchasing a new car, boat, RV, house, etc., you may find better deals and more motivated sellers during a recession. In fact, as we speak, used car inventory is increasing, which is putting downward pressure on prices. It appears as though we’re on the brink of a sub-prime automobile loan crisis with auto loan defaults at a 29 year high. With student loan payments recently resuming, core inflation stubbornly high (different from headline CPI) and credit card debt at a record high of over $1 trillion, there are sure to be opportunities in the future for individuals that are patient and have some dry powder to deploy.
In summary, while no one economic indicator should drive your investment decisions, the yield curve has historically been a good indicator of future recessions. We’re well into the inverted yield curve cycle, and while a recession may not occur until later in 2024, if history is any indicator, it’s more likely to occur in the first or second quarter of 2024.
Stock market corrections and an overall drop in asset prices typically accompany a recession. Unfortunately, we also see higher rates of unemployment, so if you’re in a market sensitive industry, you may want to buckle down so that you can weather the storm. Recessions shouldn’t necessarily be seen as negative, as it’s an opportunity to clear out malinvestments and gives entrepreneurs the opportunity to acquire assets at discounted rates, which will hopefully enable them to build their business on a strong foundation.
Similarly, individuals can benefit from investment opportunities during market corrections. While you may not be interested in starting your own business, a recession may provide you with the opportunity to purchase a particular stock that has been on your watch list or invest in a sector that you believe has upside potential.
Again, none of this should be construed as market or financial advice. We simply wanted to share with you our thoughts on the inverted yield curve, what may be on the horizon, and how you may be able to personally benefit.
If you’re interested in parking your dry powder in gold or silver or would like to allocate a percentage or larger percentage of your portfolio in precious metals, the experts at Atlanta Gold & Coin Buyers can assist. Contact us today to see why we’re the coin dealer of choice in metro Atlanta and beyond.