The word “recession” can feel scary to people who aren’t economists — especially to homeowners with a big asset to protect. And that’s understandable given that we associate “recession” with what happened in 2008, an event that took the economy years to recover from. Add to that the fact that an economic recession can lead to an economic depression — like the Great Depression that started in 1929 and lasted an entire decade — and the idea of a recession making people nervous is pretty reasonable.
But knowledge is power, and we’re going to empower you by digging into what exactly a recession is and the signs that one might be on the horizon. If you’re nervous that a recession could be looming (especially when you’re thinking about transacting in the middle of a public crisis, such as the coronavirus pandemic), here are some ways you can think about it.
What is a recession?
An economic recession is part of the normal economic cycle of growth and contraction. A recession is when the economy is shrinking instead of growing or plateauing.
A recession is technically indicated via a country’s GDP (gross domestic product). The GDP is the aggregate amount of how much money all of the goods and services are worth that were produced during a specific time period in a single country. GDP is expressed as a dollar amount in the U.S., in euros in Europe, in yuan in China, and so on.
For a country to be in an economic recession, the GDP must fall for two quarters in a row. The recession doesn’t end until the GDP begins to rise rather than fall. There is no time limit to recessions, which can develop into economic depressions or end when the economy begins to recover.
Housing market recessions
The housing market doesn’t actually experience recessions, but it can sometimes crash as a result of an economic recession or show indications that a recession is coming. The Great Recession was a global recession that happened in 2008 through 2009 and one of the first indicators it was coming was the subprime mortgage crisis of 2007 and 2008.
When a housing market crashes or the “bubble pops,” home prices that were consistently rising suddenly plateau and then begin to fall.
Tobin Bossola, a top real estate agent in Jacksonville, Florida, who worked with clients through the Great Recession, warns homeowners to avoid using their home equity as a piggy bank for frivolous things.
He explains: “If you want to reinvest that money into your home with a kitchen renovation or something where you’re going enjoy that return as well as see some appreciation,” then go for it, but be careful to avoid “things that may not benefit you in the long run or add value to your life.” “That’s where people find themselves in trouble.”
So how do I know if a recession or a housing crash is coming?
While it’s hard to accurately predict when a recession or housing crash will happen, there are several indicators you can watch. When several of these signal an economic downturn, it’s smart to brace your finances for a recession or housing crash. These signs include:
In a healthy economy, the GDP is growing year after year. When the GDP of a country slows down, it could be a sign that it is about to stop growing or even that it might start to shrink. When businesses are forced to stop producing goods or close down entirely due to a crisis, the GDP will almost inevitably stop growing and could start to fall.
You might not think of people’s feelings as an economic indicator, but the way we feel impacts how we spend, especially on expensive items like a house.
When people feel nervous, they spend less money on both short-term and long-term investments (like housing). This can have a cyclical or compounding effect on the economy and trigger or exacerbate a recession.
The bond market inverted yield curve (aka: the Treasury yield curve)
This is probably the best-known sign of a recession and the one most financial advisors and bankers cite first when they’re warning about an impending economic recession.
The inverted yield curve happens when short-term bonds deliver a higher yield (or rate of return) than long-term bonds. In a healthy market, the reverse is true, and long-term bonds will deliver higher yields.
When investors expect a greater return for short-term bonds than for long-term ones, it’s because they feel there is going to be short-term volatility and increased risk. An inverted yield curve occurred shortly before the Great Recession.
The stock market is consistently down
While the stock market isn’t the most reliable economic recession indicator, it is worth watching as the stock market can impact home prices. If the overall stock market is consistently dropping in value, companies will have less money to invest in future growth. Continued business growth is necessary for a strong economy.
However, if just a few companies are dropping in value and not the overall stock market, it’s a sign that those companies or industries are failing, not the overall economy
When a few companies are struggling, we should not see it as a market-wide concern, but when lots of companies or big companies are struggling, this can be an indicator of a slowing economy. In this case, struggling means smaller earnings growth than normal or than expected.
Company profits are an indicator only when there are several quarters or several big companies that are showing slower-than-normal or slower-than-expected earnings growth. During the coronavirus pandemic, which impacted every industry, we saw company profits sliding first, and then we knew GDP growth was going to fall.
Inflation is the increase in the general price level of services and goods that impacts the overall cost of living. When inflation rises, wages need to keep up. Historically, when inflation has outpaced cost-of-living wage increases, consumer confidence has dropped, exacerbating the situation.
Inflation is calculated by industry and averaged across industries to find the overall inflation rate. Some industries experience faster-than-average inflation and others slower-than-average, which is why economists look at the overall inflation rate.
While inflation is normal even in a healthy economy, when overall inflation exceeds 2%, it can result in an economic slowdown. Similarly, when inflation is too low, it can be a signal that demand for goods and services is lower than it should be. This can result in an economic slowdown and depressed wages.
Purchasing managers index (PMI)
The purchasing managers index (PMI) is a measure of manufacturing growth from month to month. When it slows down or dips, it’s a clear sign that the economy is slowing.
The PMI is represented by a number from 0 to 100. Any number above 50 represents an economic expansion, and any number below 50 represents an economic contraction. A PMI of 50 represents no change. The further away from 50 the PMI is, the greater the month-to-month change.
Cass Freight Index
The Cass Freight Index is a measure of North American freight shipping volumes and expenditures. While some months are busier than others, when shipping volumes and expenditures slow down or drop over time, it’s a sign that the economy is slowing down as well.
Housing construction and sales
Housing is a fairly stable long-term investment, so when people have money to spend on their homes, they do. When housing sales and construction slow, it can be a sign of a slowing economy.
Construction for both houses and commercial buildings use copper, so it’s an in-demand material. When the price of copper falls, it’s a sign that there is less demand for copper, which means fewer houses and commercial buildings are being constructed. As you know from above, that’s a sign the economy could be slowing.
Gold is considered a timeless and safe investment, especially when the economy is shaky. When the price of gold starts to increase faster than normal, it’s a sign the economy could be wobbling. The price of gold rises in times of economic instability as people seek safe, long-term investments.
Global Economic Policy Uncertainty Index
The Global Economic Policy Uncertainty Index measures how uncertain people feel about the global economy in various countries. The index is calculated using:
- The relative frequency of monthly news articles about the economy, policy, and uncertainty in 10 large newspapers
- The number of federal tax code provisions that are set to expire in the next 10 years
- The level of dispersion between the predictions of the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters. The higher the level of dispersion is, the higher the chance of a recession
Signs of a housing crash
Just as there are signs that an economic recession is coming, there are indicators that a housing crash is imminent. These forces remove buyers from the market, thus increasing the available supply of homes for sale (because they aren’t being purchased as quickly) and putting downward pressure on home prices.
Home prices rise… and rise… and rise
When home prices have done nothing but rise over the last several years, it may be a sign that they’re going to come crashing down soon. While the economy is meant to grow over time, a normal economic cycle includes expansions and contractions. Long-term home price increases could be a sign that a housing crash is coming soon to correct the market.
Homes become less and less affordable
When the gap between home prices and wages grows, the ability to buy a home slips out of reach for many people. Even those who already have a mortgage might be struggling to make payments and be considering selling or renting their home, and moving into a rental themselves.
Brant Cavagnaro, CFA, CFP, Financial Advisor at Wealthstream Advisors, Inc., recommends that “Clients with property investments should have enough cash on hand to protect them against a one-to-two year recession, since economic downturns typically are correlated with higher vacancies and drops in real estate value.”
Mortgage rates keep increasing
Very high mortgage rates put homeownership dreams out of the reach of many people and can be an indication that the housing market is about to crash. Like any market, the housing market operates on supply and demand. When the supply of houses outpaces the ability for potential buyers to purchase them, the market can crash.
When there is an economic downturn, consumer confidence drops, and people tend to be very careful about signing up for long-term expenses like a mortgage. Fewer buyers means the supply is outstripping the demand, and a housing crash might be imminent.
Home sales are declining rapidly
Declining home sales are an indication that a housing crash might be coming. When homes aren’t selling, it could be for a range of reasons, including:
- Fewer buyers who can afford rising mortgage rates or home prices
- Low consumer confidence
- A gap in consumer spending power and housing costs
A rise in home sales indicates a strong economy as buyers feel able to and confident about investing in a long-term asset. A decline in home sales indicates the opposite and that a housing crash may be coming.
The number of homes for sale is rising rapidly
The number of homes for sale can rise rapidly either because more homeowners are looking to sell and recoup their investment or because houses are staying on the market longer — or some combination of the two. When the number of homes for sale rises and begins to outstrip the demand for houses, this can be a sign that a housing crash is coming.
More homes are reducing prices
As homes stay on the market for longer, homeowners who are ready to sell and move on will start reducing their prices. This is done to attract buyers for whom the house may have previously been unaffordable or just to tempt buyers who know they would be getting a good deal.
Dropping home prices can be a very strong indicator that a housing crash is coming or has started.
Homes are on the market for longer
One of the signs of a strong housing market is that homes are purchased quickly after arriving on the market. When houses remain on the market for longer than historically normal, it can be a strong sign that the market is weakening or even crashing.
Predicting economic recessions and housing crashes is an inexact science. Even economists get it wrong all the time, so don’t be hard on yourself if you are also wrong.
Some of the first people to be aware of shifts in the housing market, both local and national, are real estate agents.
“You’re wise not to just wait and hope that you’re going to wait till it hits the bottom. If you want to buy a house and you have the means and you’re capable and you’re buying a house that was 10% more two years ago and you’re ready to buy, you should buy,” Bossola advises.
Cavagnaro agrees, explaining “The key is to not make major decisions based on short-term noise and to keep a strong cash reserve so you do not tap into your portfolio during trying times.”
Header Image Source: (Bao Zhonghui / Shutterstock)