🚗 The recession road map

Hey hey, happy Monday.

One question I keep getting these days is if the economy is in a recession. My answer? No, if I had to guess. But I want to be real with you: nobody knows when we’ll cross the mysterious line between a slowdown and a recession, even though the difference between the two can be miles wide. 

So instead of giving you a one-word answer, let me show you how I judge the health of the economy. Here’s my (simplified) framework, explained in 8 minutes of your precious coffee time.

Also, if you want to hear more of my thoughts on recessions, check out my conversation with Michelle Singletary, the GOAT personal finance columnist at the Washington Post. We had a lot of fun and covered a lot of ground.

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Don’t leave yield on the table.

One of my duties as a Wall Street strategist is to keep tabs on the global economy.

People often think that means I have a crystal ball I peer into each day, reading the tea leaves on a confusing whirlwind of data from capacity utilization to consumer confidence.

Yeah, no.

Some Wall Street experts claim they can see into the future, even predicting growth rates and stock market movements. They are often wrong because nobody can forecast tomorrow’s headlines with precision. 

That’s not my job. I don’t predict the future, and I don’t tell you what to buy and sell. 

I just think way too much about everything. I poke holes, identify risks, and tell the stories people aren’t paying attention to. I teach you to think differently.

And I do all of this through a few basic assumptions and a consistent framework, plus some clear patterns on what’s historically driven the economy forward.

This week, I want to share that framework with you, because I think it’s pretty instructive for how you should view the world around you today. Especially as people from the Treasury secretary to your local bodega owner keep talking about this recession that’s apparently here, or just ahead.

I can’t tell you when a recession will happen. But I can teach you what I’m watching to know when we’re edging closer.

A road map of sorts.

First, let’s make some basic assumptions from piles of historical data.

Recessions are painful. For your portfolio, wallet and life. The economy technically shrinks, which causes a chain reaction of all kinds of problems. Job loss, business failures, lower stock prices. It’s an all-consuming affair. Recessions are part of the natural ebb and flow of the economy, but you don’t want one. That’s why we have to be aware of them.

Recessions are rare. Thankfully, the US economy has only been in recession 10% of the time in the last five decades. And even though the S&P 500 has dropped an average of 36% in these recessions (eek!), markets and the economy have recovered every time.

You can use this knowledge to your advantage. Stay braced for the worst but prepared for the best. Recession-fueled selloffs have historically been excellent times to buy stocks at low prices—if you have the patience and risk appetite to wait. Easier said than done, fam.

You’re steering this economy. Seriously. Those little treats you’re buying add up to more than you realize. Consumer spending accounts for 70 percent of gross domestic product (GDP), which measures the size and output of our vast economic machine. 

This is very important to remember, especially as we get into my first (and biggest) belief.

Belief #1: The job market drives the US economy

If Americans aren’t making money, they aren’t spending money. And if Americans aren’t spending money, a recession is nearly inevitable.

There are no clear-cut rules of thumb in economic analysis, but this statement comes very close.

So when I’m thinking about the health of the economy, I focus on the job market. After all, the formidable strength of hiring and wage growth was what kept the U.S. economy afloat in the 2022 inflation crisis.

The key here is watching for layoffs. An increase in job cuts across industries signals that companies are making significant cost-cutting measures to adjust for lower demand.

And in my experience, the best metric to watch for layoffs is initial jobless claims – or first-time claims for unemployment benefits. As you can see in this chart, initial claims have picked up an average of 12 months before a recession, and they end up increasing by an average of 20% before the downturn hits.

We’re in a weird stage with the job market. Initial claims are about 10% higher than they were in 2022, but the level of claims is on par with the late 2010s. I’d be more worried if we see a sudden, sizable jump – plus more rumblings of pending layoffs through WARN notices (required layoff notices in specific situations).

Are we there yet? Sort of. Companies aren’t hiring a lot of people (bad) but they also aren’t firing a lot of people (good). We have, however, seen evidence that layoffs may be increasing, especially in the federal government.

Belief #2: Americans can tell when something is off

Spotting a recession requires more than just job market data—it also means gauging Americans’ confidence in their finances and the broader economy.

Because when people feel terrible, they often do because of larger systemic issues, and they’ll probably change their spending habits because of it. Not always, but we’ll get to that in a second.

Luckily, there’s a Conference Board gauge that measures consumer confidence – with a rich history of data spanning more than five decades. What we’ve seen since 1970 is that confidence has started to drop an average of 12 months before a recession has started.

Confidence isn’t always a reliable indicator. For example, in 2022, the Conference Board’s confidence measure dropped by 30 points—a decline typically seen only around recessions. Yet the U.S. economy survived because Americans kept spending money.

What gives?

You’ll see if you divide confidence into present conditions and future expectations, or the two main factors of your feelings.

In 2022, people generally felt great about their own finances. The drop in confidence was more about future expectations.

Yes, confidence drops before recessions. But I’ll take it a step further. Present and future confidence drops before recessions. You can feel as anxious as you want for tomorrow, but today is what really matters when it comes to your money.

Are we there yet? Again, sort of. Americans’ perceptions of their present situation and future prospects are both souring. Not the trend you want to see.

Belief #3: Companies need to be able to borrow money

There’s a saying on Wall Street that you should have fun in the stock market and marry the bond market.

OK fine, I made that up. But when you’re looking for economic cues, it’s often better to look at the $141 trillion bond market over the $115 trillion stock market.

Companies and governments borrow trillions for operations—not out of irresponsibility but because borrowing is often a smarter financial strategy than spending cash reserves. Or you’re a young company and you can’t build big things without loans. Capitalism runs on risk and leverage.

We often take the debt markets for granted, but they’re crucial to corporate America’s success. When companies aren’t borrowing or investors don’t feel comfortable loaning, the world’s biggest market freezes up. And more often than not, chaos ensues.

You can tell how accessible debt markets are by interest rates. And often, before a recession, investors start pulling back from issuing and borrowing – because they’re nervous about the future or less certain that they’ll get paid back.

So when you’re trying to take the temperature of the economy, look at what Wall Street calls spreads – or the interest rate investors are demanding for corporate debt beyond similar Treasuries. If you need a quick explainer on debt, I’ve got you.

Spreads on the riskiest “high yield” companies tend to rise when there’s financial stress. You can see on this chart that they were early signs for the dot-com era recession and the global financial crisis.

Spreads also rose during the 2011 European debt crisis and the 2015 Chinese growth slowdown, two of the most notable economic shocks during the 2010s.

Are we there yet? No. Spreads are rising, but they’re still far below historical levels. This is understandable – a lot of companies took out cheap interest-rate debt in the 2010s and early 2020s, so they’re fat and happy. It’s hard to have a downturn when people – and companies – are sitting on lots of cash.

Belief #4: We need a shock

Recessions don’t just happen, folks. Look back through history and you’ll see that more often than not, the economy tips over the edge when a particular event pushes it. Be it a war, a pandemic, a tech stock meltdown, or an unexpected interest rate adjustment.

I’d even go as far as to say this assumption is more true today, given technological advances on supply chain and inventory software and a shift away from manufacturing. Something has to force Americans to stop spending money.

It’s hard to say what that something will be, but I’ll entertain the idea of DOGE and tariff-related risks being that shock.

Are we there yet? Possibly. Policy changes could be that shock. Government spending cuts are likely in the near future. And if dramatic tariffs keep companies from expanding, we may have a toxic job market situation on our hands.

So that’s how I’m thinking about this environment in a very distilled, simple nutshell. Focus on spending and lending, ignore (most) everything else. 

If we see evidence that companies are cutting jobs, people are losing confidence in their current financial situations, and lending markets are seizing up, then I’ll be worried about a recession – and subsequently, a big market drop.

But I want to stress a point made higher up: I have NO idea when the next recession will happen. Nobody does. It’s also totally possible that the next crisis looks different than ones in the past. We’ve already seen some classic economic metrics flash false signals in the past few years, and the world is pretty chaotic at the moment.

I know words sound hollow without actionable steps. I’m not here to give advice, but I do know when these beliefs are tested, it’s time to make a plan.

Check your savings/emergency fund, understand what you’re invested in, and create a list of what you’d do in certain scenarios – if you lost your job, if the S&P 500 fell 20%.

We are not there yet. But we may be soon.

Thanks for reading!

Callie

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