Keep An Eye On These Three Big Real-World Recession Indicators

Keep An Eye On These Three Big Real-World Recession Indicators
Paul Allison, CFA

11 months ago5 mins

  • Bank of America’s “dirty dozen” charts point to a looming recession, but you don’t have to keep tabs on all 12 economic indicators.

  • Instead, you can follow these three real-world economic gauges closely and you’ll get a heads-up on the potential shape and size of a coming recession.

  • To brace for the recession signaled by these indicators, you could consider lightening up on stocks, adding defensive assets to your portfolio, or, better still, use the negative outlook to tighten up your long-term stock-picking process.

Bank of America’s “dirty dozen” charts point to a looming recession, but you don’t have to keep tabs on all 12 economic indicators.

Instead, you can follow these three real-world economic gauges closely and you’ll get a heads-up on the potential shape and size of a coming recession.

To brace for the recession signaled by these indicators, you could consider lightening up on stocks, adding defensive assets to your portfolio, or, better still, use the negative outlook to tighten up your long-term stock-picking process.

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Don’t look now (or actually maybe do): Bank of America has recently put together 12 economic charts – what it’s calling the “dirty dozen” – and they’re all pointing toward a recession. These ugly-looking indicators reach beyond the usual yield curve recession signals, and offer a clear look at what lies ahead across the economy. I’ve pulled out three that you’ll want to keep an extra close eye on.

1. The price of oil

Like all commodities, oil’s price is set by demand and supply. And over the past few months a couple of things have happened that should’ve lit a fire under the black stuff. For one, China – the world’s largest oil importer – reopened from pandemic-induced lockdowns. And while the country’s economic recovery has so far fallen short of everyone’s lofty expectations, it’s still generating demand for oil that wasn’t there last year. For another, OPEC+, the group of oil-producing nations, cut its production targets twice, and meaningfully brought down supply. In theory, those two things alone should’ve created a healthy backdrop for a robust oil price. And sure, at $87 the price of a barrel of Brent crude oil is up from its March low of $66, but that’s still substantially below the $122 peak it hit following Russia’s invasion of Ukraine.

Zooming out then, Bank of America reckons that oil price tag is proof that underlying demand is actually weakening. And the bank cautions that a falling oil price can be an accurate predictor of recessions. So you’ll want to be keeping tabs on oil’s progress in the coming weeks, and that’s easy enough to do with a simple Google search.

The price of oil (blue line) has tended to fall as recessions (gray shaded bars) have kicked in. Source: Bank of America.
The price of oil (blue line) has tended to fall as recessions (gray shaded bars) have kicked in. Source: Bank of America.

2. Home prices

Victorian Britain popularized the phrase “as safe as houses”. But ask New Zealanders how they feel about that old saying right now and they’ll likely puff out their cheeks. House prices in the island nation (teal line) are down 14% compared to last year’s levels. Kiwis are in good (or unlucky) company, mind you. Home prices fell last quarter in two-thirds of the countries tracked by the Organisation for Economic Cooperation and Development (OECD). The chart shows that prices in the US (orange line) were still higher compared to last year, but that might not hold for much longer: the OECD’s tracker shows they’re lower this quarter than last.

Global house price changes, annually. Source: Bank of America.
Global house price changes, annually. Source: Bank of America.

And housing matters. See, your home tends to be your biggest asset, and when its price falls, you feel poorer and less inclined to splash out on other things. That hits overall consumer spending and, in turn, the economy, especially in developed countries where consumer spending makes up between 60% and 70% of economic growth. Now, there are a ton of indicators about house prices, with some focusing on newly built homes, for example, and others focusing on existing ones. But for a look at the whole sector, your best bet is the quarter-by-quarter view from the St. Louis Federal Reserve.

3. Jobless claims

Once a month the US Bureau of Labor Statistics releases its big “nonfarm payrolls” data and macroeconomic enthusiasts get all hot under the collar. See, this key report is seen as the most important for taking the temperature of not just the job market but also the whole economy. Initial jobless claims, a report that comes out every Thursday and tracks how many workers are filing for new unemployment benefits, meanwhile, tends to slip under the radar. But it shouldn’t. For one thing, the data’s released weekly, so that makes tracking a trend easier and quicker. And for another, it’s worked like a charm in predicting recessions before.

Take a look at jobless claims (light blue line) in the chart. Ignoring its dramatic collapse during the pandemic, the series was an early predictor of the last recession in 2008-09. It started hinting at trouble in 2006, some two years before the recession kicked in, and well before most investors had cottoned onto the brewing global financial crisis.

Initial jobless claims (light blue line, inverted) and small business loan availability (dark blue line) are correlated and strong predictors of an upcoming recession. Source: Bank of America.
Initial jobless claims (light blue line, inverted) and small business loan availability (dark blue line) are correlated and strong predictors of an upcoming recession. Source: Bank of America.

In the chart, Bank of America has draped the jobless claims data (inverted) over small-business lending data (dark blue line) because, as the bank points out, these two tend to be closely tied. And it makes sense: in tough times, small firms can struggle to get bank loans to support their businesses and end up laying off workers. So, if that relationship holds this time around, then the drop in small business loans shown in the chart should lead to a rise in jobless claims, and, as we know, that’s a clear sign that a recession’s afoot. To keep on top of this data series, you can use the St. Louis Fed again.

What can you take from all this?

Like Bank of America’s dirty dozen, these three important gauges point to a near-certain conclusion: a recession, with all the usual associated job-loss, home-price, and stock-damaging consequences. And, if that’s what’s in store, you might want to consider selling some of your stocks, particularly ones from sectors that are most vulnerable in tougher economic times.

But if you’re inclined to stay invested (time in the market is better than timing the market, after all), you might want to add some classically defensive stocks to your portfolio – those that hail from the consumer staples or healthcare sectors, for example. The iShares S&P 500 Consumer Staples Sector ETF (ticker: IUCS; expense ratio: 0.15%) and the iShares S&P 500 Healthcare Sector ETF (ticker: IUHC; expense ratio: 0.15%) are two broad-based defensive investing options you might consider.

And in the meantime, you might want to bookmark these indicators: they can give you a good view of what’s happening at the big-picture, macroeconomic level. Now, I’m a firm believer that you shouldn’t let the macro view exclusively dictate your stock selection – conditions can shift suddenly, and even if they don’t, there’s no guarantee that a stock will behave the way you’d expect.

Instead, consider adopting a cautious macro view, and continually consider this one very important question: if this stock falls, are you prepared to buy more? Now that question’s a good one at any time, but it’s particularly relevant ahead of a recession. If the answer’s yes, and you have a long-term tilt, you can use a negative economic view to your advantage. See, if you narrow your focus just to stocks that you’re prepared to hold for the long term and buy even more of if they fall, you’re bulletproofing your stock selection process and your portfolio. And that can only boost your returns in the end.

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