As we all began to emerge from the pandemic in 2021, Americans started spending more after being stuck in their homes. Holiday shopping was up, unemployment numbers were down, and it’s safe to say that many of us were feeling optimistic about our finances heading into 2022. However, things began to change with increased labor costs, stalled supply chains and rising interest rates.
Could these be signs of a recession?
What Is a Recession?
An economy is considered in a recession after two consecutive quarters of economic decline. Economic decline is measured by negative gross domestic product growth. The GDP is reported after the quarter is complete, meaning it is possible that a recession has already been underway for a few months before it becomes official. Nowadays, there are many other factors that are used to measure whether a recession is occurring, including employment numbers, wholesale-retail sales and real income.
While recessions can be uncomfortable for us and our finances, they are a very normal part of the business cycle.
Many of us think of high interest rates or a stock market crash as the cause of recessions. But there are a number of factors that can play a part. Falling housing prices and sales can slow down the economy. If homeowners begin to lose equity in their homes and cannot take out a second mortgage, they may be forced to cut back on their spending. Panic by consumers can also affect overall spending when people become nervous about the state of the world and stop spending their money. Poor business practices have caused recessions in the past. There are many factors that can affect how we spend or invest our money, and we need to be prepared for them all.
Recessions Throughout History
The United States has experienced 19 recessions throughout history, and 14 have happened in the last 100 years. A few of the most memorable are The Great Depression, caused by the stock market crash of 1929, and the recession caused by the dot-com bubble bursting in 2001. And of course, many of us remember very well the Great Recession in 2008 caused by the global bank credit crisis.
While they all vary in length and severity, recessions last just under a year on average. While it may be hard to predict, there are signs we can look for. Rising interest rates, high inflation and a negative yield curve can all be signs a recession may be around the corner. As mentioned above, while we can try and spot the signs of a recession, many times they are almost over by the time we recognize them.
Prepare Now – Your Finances Will Thank You Later
While we may not be able to spot a recession before it starts, we can prepare for one. Between the current interest rate hikes and a negative yield curve, an increasing number of analysts believe a recession may be coming. There are things you can do now to prepare for the financial impact later.
Build up your emergency fund as much as you can. Try to have at least six months of expenses covered in case of unexpected job loss or illness. This may mean changing your budget and spending more on things you need – not necessarily what you want.
If you are investing in the stock market, look at your portfolio. Consider changing your investments to companies that sell products people need, such as food or gas, instead of wants like luxury goods or electronics.
Your short-term assets can also be helpful to you during a recession. These types of assets are to be used within one year, so they are ideal to help get you through an economic downturn. These can include cash, prepaid expenses, or any short-term investments. Relying on a short-term asset allows you to take advantage of more opportunities when the economy begins to recover — all of this without having to dip into any of your long-term investments.
A financial adviser can work with you to come up with the right plan for you. The biggest takeaways are: Don’t panic, and stick with your plan. Recessions historically don’t last long, and our economy can come back even stronger.