Economic Red Flags That Indicate A Recession Could Be Near
It’s every investor’s worst fears come true – a market correction that turns out to the beginning of a larger bear market. If you saw the threat coming, you might not be surprised when it hits or even notice much of a change in your portfolio’s performance if you made preparations. But those that don’t see the warning signs could see their portfolio’s performing gut-wrenching dives.
Luckily, recessions don’t happen by random occurrence, except for certain rare black swan events such as an asteroid strike or something of that nature. For the most part, recessions give signals before their arrival giving investors who know what to look for time to adapt. By following the right line of data, you should be able to determine at the very least if market conditions are headed towards trouble.
Key indicators to watch out for
One of the most tried and true methods for forecasting recessions is by examining overall market margin levels. Historically, a rise in margin levels has preceded a recession making it one of the most accurate predictors investors have. Interestingly, margin levels at the moment are over $580 billion – a record high. With margin levels so high, there’s a lot of leverage in the markets. If a downturn happens, there could be a lot of selling to cover losses which could then trigger a deeper bear market.
Another good indicator is the average price-to-earnings value of companies listed on an exchange like the S&P 500. The mean P/E ratio comes out to be 15.70 so figures higher than that mean that the market is becoming overvalued. Right now the average P/E is 24.54, considerably higher than average. But the market can sustain high values for years before reversing course so while the P/E ratio is a good indicator of value, it doesn’t mean that a recession will happen tomorrow.
Another thing to watch for is a flattening of the yield curve. Normally, longer-term bond yields are higher than shorter term due to the time value of money. But when a recession nears, short-term yields can overtake longer-term ones indicating that investors are preparing for a possible market reversal.
The market is notoriously fickle, and trying to time a bearish reversal is far more difficult than simply identifying that the risk of one is higher than usual. Recessionary forces can stay high for long periods of time before it finally becomes enough that the economy enters a downturn. In practice, red flags should mean that investors take care to add defensive positions to their portfolio and avoid undue risks that could result in heavy losses if the market suddenly enters a corrective phase.