🕵️‍♂️ Spotting Recession

Delving into 2 key indicators and providing essential insights to help you navigate and identify the onset of a recessionary period.

By now, most of us would have understood what recession is and in fact, some of us even would have already faced the snowball effects due to recession. So I am not gonna rant about what recession is. However, if you want to understand what and why a recession happens, I would suggest watching Johnny Harris's video where he beautifully articulates Recession in under 15 mins.

With that said, I am gonna throw out a few factors on how to identify recession.

There is no correct explanation for the recession. It's very subjective and every economists have their own theory of explaining recession. But there are 2 key popular data/indicators that can help us to identify recession.

📉 GDP Contraction - Indicator #1

If there are 2 consecutive quarters of GDP contraction, then technically we are in a recession. Apparently, if you see the GDP data of the US, the States is already in recession.

But hold on, by this data only the US economy is in a recession right? No matter what you say, the world markets (including the Indian markets) are mirrors of US markets.

“If the US sneezes, the entire world catches cold”

Digging deeper, GDP contraction means the economic output of a nation declines when the nation is producing fewer goods and services than it did before. So when fewer goods and services are produced, fewer resources are used by companies - including Human resources. Hence that's why you are probably seeing huge layoffs across the world.

🏪 Yield Curve - Indicator #2

Another graph that clearly indicates a recession is the Yield Curve.

The Yield curve is nothing but the bond yield rates. Long story short, inverted yield curves can often but not always predict a recession.

So how should an ideal yield curve be?

The short-term bonds should have a low percent rate of interest and long-term bonds should have a high percent interest. But if this gets inverted - like short-term bonds get high percent interest and long-term bonds get low percent interest, then it is termed as yield curve inversion.

For example, in ideal scenarios, a 3-year bond would have 3% interest whereas the 10-year bond would have 5% since it is a long-term bond. And if you invest 100$ in a 3-year bond you would get 3$ in return and 5$ in a 5-year bond.

But why does a long-term bond give you more return? Cause the longer the bond, the higher the risk. Higher the risk, the higher the rate of return. Simple economics rule.

However, it may happen that the demand for the short-term bond might fall and the banks might reduce the cost of the bond from 100$ to 60$ but in order to get the exact ROI of 3$, they had to increase the interest rate to 5% from 3%.

Similarly, if the long-term bonds are having a surge in demand, the banks might need to increase the cost of the bond price from 100$ to 120$ but again in order to get the same ROI of 5$, they have to decrease the interest rate to 4%.

So the big picture → short-term bonds have their interest rates increased and long-term bonds have their interest rates decreased, which means the bank has to pay back a lot of money as returns to the bondholders, especially the short-term bondholders.

This domino effect leads to a shortage of funds in the banks leading to recession. That is the reason there has been a lot of bank collapses in recent times such as the SVB bank and the Credit Suisse collapses. I have also blogged about the bank run that happened recently at SVB - check it out here.

🌦️ Any other indicators?

Apart from these, economic inflation, tech layoffs, labour market and low GDP are some other indicators that can spot a recession. But one of the other indicators that caught my attention was - Quiet Luxury.

Yeah, that was right - luxury can predict recession and quiet luxury is well-tailored, logo-free clothing in neutral colours which is extremely contrary to the fashion styles. According to brand research firm Edited, “Quiet luxury provides investment pieces with a year-round appeal that offers consumers a good cost-per-wear return.”

Quiet Luxury places a paramount emphasis on quality over trends, delivering enduring intrinsic value to customers. As a result, consumers gravitate towards quiet luxury during times of recession, seeking to curtail their expenses intelligently.