Run for the hills! A recession is coming!

At least… that’s the scary narrative pundits have been talking about for months now.

The prices for gas have risen more than expected in the last few months. Even the prices for necessities like food, rent, and home purchases have gone up, too.

Studies show that all but one of the U.S. recessions since World War II has been preceded by a spike in the price of oil, which we just saw.

NPR stated that some of the top CEOs have been warning about a recession coming due to the inflation hitting the highest rate in 40 years.

And because of inflation, consumer spending has slowed, and we’ve seen big stores like Walmart and Target taking a hit. All this means that economists have been carefully monitoring the U.S. GDP, or gross domestic product, to see if there will be a recession.

In the first three months of 2022, the GDP has dropped 1.4%.

And over on Kitco, they speak about the upcoming recession as a foregone conclusion.

Well, I mean…

They’re right.

America IS going to experience a recession at some point in the future. 100% guaranteed.

These things happen. Nothing grows forever. Even made up stuff like the economy.

But that’s neither here nor there.

The question people want to know is: When will we experience a recession?

And another question is: How will this impact you and your wealth?

And still another question is: What’s a recession, what’s an economy, what even is any of this stuff?

Now, fun stuff, we actually have answers to all three of these questions!

So let’s tackle them in reverse order, and by the end of this piece I’ll show you the actual hard proof we have that tells us whether we’re going to see a recession or not, and when we should reasonably expect it.

Let’s get started.

“What’s an Economy?”

Ok, so… chances are you like stuff.

When you want a “stuff,” you go to the the stuff store and buy it, usually by using a currency we’ll call stuffbucks.

That store used its own stuffbucks to buy stuff from a stuff wholesaler, who also used dollars to buy stuff from a manufacturer of stuff, who also used stuffbucks to buy the materials needed to make stuff from a stuff-material supplier.

Along the way, shippers got paid to move stuff. Warehouses got paid to store stuff. Utility companies got paid to power all this stuff, and they paid energy companies to drill up energy-stuff from the ground.

Second-hand markets opened online to sell stuff. The black stuff market allowed people to trade more illicit sorts of stuff.

Entrepreneurs eager to get into the “stuff” market got loans from banks to start their stuff enterprises. Banks sold these stuff loans to other institutions so they could always keep cash on hand to fund more stuff. And vertically integrated stuff companies wanting to expand their businesses sold portions of their company (“equity”) on the public stock market to raise more stuffbucks so they could make more stuff.

And so on.

Multiply all that by enough industries and markets throughout the United States and you have

✨ The Economy ✨

When more people are buying more stuff, and companies are making more stuff for people to buy, all this activity in aggregate indicates that an economy is growing.

We like it when economies grow. More economy equals more stuff.

A greater supply of stuff means more money changing hands, which means more jobs, which means more money ending up in the pockets of regular people like you and me.

When people of a regular persuasion have more money, they demand more stuff!

So the cycle begins anew. The snake shall eat itself.

Bingo bango: you now have a B.A. in the pseudoscience of economics.

But maybe not everything is hunky dory in our stuff-based economy.

What if demand for stuff declines?

What if a crisis happens that destroys a lot of jobs and eats away at the stuffbucks people saved?

What if, and I’m going to invent a totally made up scenario here, the returns on stuff stocks have been declining for years so banks, that want to make more money selling stuff loans, decide to bundle these stuff loans together into what they’re calling Collateralized Stuff Securities (CSS) and sell them to funds and pensions and other financial institutions wanting the high income and low risk that comes with them, but banks end up making so much money that they encourage people to take out riskier and riskier stuff loans but then these same banks don’t disclose this risk to the people and businesses buying the CSSes and the speculators making side bets on these CSSes don’t know what the hell is going on and eventually everyone is saddled with a bunch of assets they were promised were risk free but it turns out they’re not and some of them end up becoming worthless as the original businesses that took out the stuff loans go bankrupt and all the banks and financial institutions and funds that had borrowed money to buy these stuff loans don’t have the money to pay back their own loans and they end up at risk of collapsing which would collapse the entire stuff economy resulting in everyone losing their money and their jobs and their stuff?!?

Ahem. Not that something like that would ever happen ever.

Anyway, when the economy doesn’t grow for whatever reason, and it declines for at least six months (two quarters), it’s called a “recession.”

Now, notice how a recession doesn’t cause jobs and money and stuff to disappear.

Recessions are labeled during or after an extended economic decline.

(This is an important detail. Remember it for later.)

First the decline happens. Then somebody (NBER, probably) comes in and goes, “Whoa, yeah, uh… that thing that just happened was totally a recession.”

What triggers recessions to begin?

The simple answer is: People and businesses demand less stuff.

The more complicated answer: Fluctuations and changes in investment spending, government spending, net export activity, consumption, corporate investment decisions, capacity utilization, household income, interest rates, demographics, employment levels and skills, household savings rates, and government policies.

Phew! Ok!

Now you should know what an economy is, why we want it to grow, and why we don’t want it to recede.

High tides raise all boats, and whatnot.

Nerds who study the economy, called “economists,” use a terrible and problematic measure of economic activity called the Gross Domestic Product (GDP) to detect whether economies are growing or not.

This is what the U.S. economy looks like:

Pretty good, right? That’s lots of trillions of dollars’ worth of activity. America: it rules.

But those shaded gray areas? Those are recessions – stretches of time when GDP went down.

Now… you might be looking at this chart and thinking: “Huh, that doesn’t seem so bad. Even with little pullbacks, the line keeps going up.”

And you would be correct!

In the grand scheme of things, recessions aren’t that scary. Just like pullbacks in the stock market.

But when they’re happening?

Well, cripes, the world feels like it’s collapsing.

The media screams about how the president is terrible. Companies fire people to save money. People gnash their teeth and tear out their hair and beat their chest. Too many people apply to grad school. Everyone drinks too much.

Recessions are a bad time.

And that’s why they matter to you, the wealth builder and/or investor.

“How Do Recessions Affect Me & My Money?”

If you’re a business owner and economic conditions are harsh…

It could be difficult for you to get a loan. It could be hard to sell your products (because there’s no demand, because no one has any money). It could be hard to afford to keep your employees, your assets, your inventory, your stuff.

So in the leadup to recessions, many industries “tighten the belt,” so to speak.

Here’s the thing…

If businesses are tightening the belt, that means they aren’t investing money back into their business to grow it. Or they’re not distributing as much wealth back to shareholders (i.e., investors).

They say that the economy is not the stock market, and the stock market is not the economy…

However, it’s here where receding economies impact investors.

Because obviously people want to buy the stocks of companies they think are going to grow and reward them in the future.

But if people don’t think a stock will reward them for their investment?

Well, they’ll sell it.

Lots of buying makes stock prices go up. Lots of selling makes stock prices go down.

That’s why we typically see bear markets (significant drawdowns in the stock market) coincide with and often begin before a recession.

Here’s how Scott Bauer for the CME Group puts it:

“When the economy is strong, consumer and business spending increases and corporate profits improve. Greater profits support higher stock prices. Conversely, when economic activity slows, spending declines, profits are reduced, and stock prices fall. The stock market typically continues to decline sharply for several months during a recession. It historically bottoms out approximately six months after the start of a recession and usually starts to rally before the economy picks up.”

You can see the connection between recessions and market declines in the chart below:

Important to note…

Most of the “pain” felt by investors occurs in the last 6 to 12 months before a recession occurs.

And that’s because…

(Remember when I told you to remember that important detail about recessions only getting labeled during or after economic declines?)

When an economy declines… people tend to notice it.

People notice unemployment going up. They notice that they’re making less money, or that their money can’t buy as much stuff. They notice that there’s a bunch of closed shops and foreclosed homes in their neighborhood.

And because all of these events and trends are so easy to notice…

We have some pretty reliable indicators that predict a recession is going to occur some time (months to years) in the future.

So naturally: When investors see the plain-as-day data the economy is beginning to slow, they want to bail out of their investments.

This drives stock prices down before a recession officially begins.

Also naturally: Six months (two quarters) after a recession officially begins, it’s usually an indicator that things will improve economically from there, so people begin to pile money back into the markets again.

This drives stock prices up while a recession is still taking place.

And the cycle begins anew. The snake shall eat itself.

“Enough Blabber. Is the U.S. Going to Have a Recession or Not?”

So now that folks all over the world have had their ear and eye holes filled with doomsaying about inflation and higher costs, the supply chain crisis, Chinese economic defaults, central bank interest rates, the war in Ukraine, the great resignation, new variants of SARS-CoV-2, corrections and bear markets…

And so on.

These are all things that can impact and lower demand among consumers and businesses.

And as we laid out above, if demand declines, so does economic activity.

That’s why you have people like the president and chief economist of Rosenberg Research & Associates Inc. convinced we’ll see “a recession starting sometime this summer — as early as June and as late as August.”

That’s… aggressive. And frightening.

But let’s quickly go over the facts we established above.

It becomes clear we’re in a recession after 6 consecutive months of economic decline…
Stocks decline in value in the six months before and six months after a recession…
This is because investors respond to indicators that the economy is weakening.

That means, if we see economic decline between January and March, the soonest we could possibly expect the U.S. to “officially” enter a recession is June to September.

So will that happen? Will the U.S. enter a recession in 2022?

I doubt it.

Because we have one indicator that has, without fail, told us whether we will experience an economic recession or not within the next year or two.

100% of the time, we see what’s called an “inverted yield curve” in the 12 to 24 months before the U.S. enters a recession.

“The Heck is a Yield Curve?”

The “yield curve” is something you’ll see a lot in the financial news, but you probably have no idea what it means.

Basically, the U.S. issues (that is, sells) treasuries. The true global currency.

A bond is a loan to banks, financial firms, countries, and people like you and me.

If you take a loan, you have to pay back interest on top of the original loan amount. So anyone who buys a government bond receives a regular interest payment from the government for a set amount of time.

This set amount of time is called the maturity date. The U.S. issues debt with maturity dates ranging from a few weeks to 30 years.

The percentage of this income compared to the cost of the bond is called the yield.

Follow me so far? Yield = a bond buyer’s income until the bond maturity date.

Now, here’s a question: If you had to choose between a dollar now and a dollar 20 years from now, which would you choose?

Probably a dollar now.

In the same way, investors want a bigger income reward for buying bonds set to expire further in the future.

Their money is locked up for longer, after all, and potential risks and opportunity costs can build up over time.

So if you plot bond yields against time on a graph, it SHOULD look like this:

A curve! Of yields!

Here’s what it looks like now, compared to how it looked around this time in 2021 and 2020:

Still quite curvy!

But when this curve starts to become like a straight line (as it did in 2020), that means the yield curve is “flattening.”

And if any of the yields in the short term are bigger than the ones in the long term, that means the yield curve has “inverted.”

A flattened yield curve is cause for concern…

While an inverted yield curve means “danger is definitely ahead.”

That’s because, if investors demand a higher yield now as opposed to in the future, it means investors perceive more risk in the future than the present.

If you subtract the 3 month yield or the 2 year yield from the 10 year yield, you get what’s called the “spread.”

If these spreads are ever a negative number, you can expect a recession within the next two years. Like clockwork.

Here’s what these spreads look like over the last 42 years (recessions in gray):

Notice how the yield curve inverts (meaning: these spreads become negative) leading up to every recession?

That means, as things stand right now…

We should NOT be expecting a recession to begin in 2022.

Not yet, anyway.

The 10 year - 2 year spread is flattening and becoming dangerously close to inverted.

The 10 year - 3 month spread typically follows a few months after that.

At this rate, the yield spreads will give us a clear answer to the recession question in the coming months.

But so far, things are looking… well, not “good” for 2022.

Things are somewhere between “fine” and “mixed.”

2023 or 2024 though?

There’s definitely cause for concern.

Fortunately, you have a little bit of time to prepare.

My advice:

If you’ve got a job, work on making yourself a more valuable employee to the business by becoming an “intrapreneur.”
If you’re an investor, shift your investment strategy slightly away from growth and more towards a defensive, longer-term strategy that pays income, like the funds I recommended for the Finance Daddy $10 Daily Challenge.
And if you’re a human who breathes air, get aggressive about building up your Emergency “Start Fresh” Fund.
Get your money to make money for you - learn how to “super-compound” your wealth starting today.

A lot of this advice is stuff I talked about in greater detail during an interview I did with a writer for Cheapism.

Listen, you can never know what the future will hold…

But the things you need to do to feel secure and ready for anything that can happen?

Pretty straightforward and simple.

You just have to do them.