Understanding Key Recession Indicators

By Megan Anderson, Vice President Public Relations

If you’ve read the news lately, you know that media headlines are spreading fear about a recession on the way. What does this mean for your business, your clients and the housing market?

In this article, we will define what a recession is and how to understand crucial recession indicators. We will also cover what has happened historically to the housing market during times of recession. This knowledge will help you explain this critical information to your clients and help them overcome any fears they may have about purchasing a home during recessionary times.

What is a Recession?

A recession is a decline in general economic growth. The technical definition of a recession is two consecutive quarters of negative economic growth as measured by Gross Domestic Product (GDP).

Recession indicators are very important, especially when it comes to the mortgage business. When recessions happen, interest rates drop. And if you know a recession is coming, you can be a much better adviser for your clients and help them find the right strategy for their situation.

For example, if in 2019 you had watched MBS Highway’s morning update videos where we break down various economic and housing reports, we knew there was going to be a refinance opportunity during the coming recession. We explained to our originator clients that they should advise homebuyers to not pay heavy closing costs or upfront fees because these upfront costs didn't make sense when people would benefit from refinancing a short time later.

Our clients were very happy – and so were their homebuying customers. Understanding recession indicators give you a key to see into the future so you can best help your clients.

Here are the recession indicators the team at MBS Highway looked at to successfully forecast the 2020 recession before COVID hit.

Unemployment Rate

Contrary to what many people may think, recessions happen when the unemployment rate is low, rather than high. In fact, a key recession indicator occurs when unemployment levels reach their lowest levels and start to tick higher.

Looking at the graph below, the dark blue bars represent past recessions. The white line is the unemployment rate, and you'll notice that every time the unemployment rate hits the low and begins to tick higher, we have a recession.

 

The reason for this is that when businesses are good, they're growing. As they grow, they hire more people, and as they hire more people, the unemployment rate goes down. But the second a company’s business begins to slow down, they stop hiring – and if business slows down enough, they begin to let employees go. Those individuals then join the unemployment ranks and we see the unemployment rate begin to tick higher.

What’s more, when people lose their job, their spending patterns change. They are less likely to go out to dinner, buy a new car and take a vacation.

As this happens those businesses, restaurants, car dealerships and airlines begin to feel a slowdown in their business – and they may also stop hiring or begin to lay off more employees. The cycle keeps perpetuating itself and this is what leads us into a recession.

Corporate Debt

Rising corporate debt can also coincide with recessions because as business slows, a need for borrowing may rise. However, this added overhead can make businesses even more vulnerable during downturns because they need to increase profitability to pay for this debt.

In addition, if business activity declines, those businesses may reduce headcount even more rapidly to stay afloat, which adds to the unemployment cycle, as noted above.

Inverted Yield Curve

This recession indicator is what has been making splashes in media headlines. What does an inverted yield curve mean? Normally, you would expect to receive a higher rate of return for putting your money away for 10 years versus 2 years. But when there is an economic slowdown and fear in the markets, the yield curve can go inverted – meaning that 2-year yields are higher than 10-year yields, which is backwards or upside down.

 

Think about it like a CD at a bank. If you were to compare rates on a 1-year CD versus a 10-year CD, you would expect the longer, 10-year commitment to yield a higher return on your investment. But what if the opposite were true and the 1-year yield was higher? This would be unusual.

Again, the yield curve can become inverted when there is economic slowdown or fear in the markets. The slowdown leads to pricing pressure, as prices can’t be raised in a slowing economy, which can lead to deflation.

Deflation makes future dollars more valuable because they will have added buying power in purchasing cheaper goods. Normally, we expect the cost of goods and services to go up over time. But when there is a belief that the economy is slowing down, prices usually stay the same or drop. Again, this means that money in the future will be worth more.

Synchronized Recessions

World economies are interconnected and countries rely on each other for trade. This is why recessions don’t typically happen to just one country at a time. Typically, an average of 50% of global economies experience recession at the same time, a phenomenon known as synchronized recessions.

 

The good news is that countries not experiencing a recession may be able to help those countries in a recession pull out of it. There are exceptions, such as the global COVID pandemic that put nearly 93% of economies into a recession. Note that when there is such a high level of synchronicity, recessions can last longer and be harsher because there are fewer countries to help pull the others out.

World Trade

World trade is another reliable indicator of forecasting recessions because when global trade begins to slow down, it leads to a recessionary period. Note that recessions do not occur when world trade is flat. Instead, they occur when trade moves beneath the zero or flat level and trends even lower. It's the decline, not the trough.

 

Could just one of these indicators signal a recession? It could, but when we get a confluence of these indicators, we can really get a strong inclination that there is going to be a recession. Much like when we're looking at the market, we look at Japanese candlestick patterns, resistance levels, moving averages, stochastic crossovers, and other measures to get a read on where the market is headed. It's the same thing when it comes to recessionary periods.

Remember, it's important to understand all these indicators if we're going to help our clients pick the best loan option for their situation. You can learn more about recession indicators and the mortgage industry on a macro-level by taking our Certified Mortgage Advisor course. This knowledge has made a powerful difference in my life and my career.

What Happens to the Housing Market In Recessionary Periods?

The media would have you believe a recession is a bad thing for the housing market. The truth is that every single time there has been a recession you see interest rates on mortgages decline. This creates a big opportunity for people because they can refinance their current loans to lower rates or pull cash out.

 

What about real estate? Again, the media would have you believe that real estate will have a tough time during recessionary periods – but this couldn't be further from the truth.

The darker colored bars on the graph below represent all the past recessions that have occurred. The white line represents home prices according to Case-Shiller. You will see that in eight out of the last nine recessions, real estate values increased during the recession and went up right after the recession was over.

 

The exception occurred in 2009, when home values declined. But when we look at this situation more closely, it wasn't the recession that caused home values to decline – it was the housing bubble. Lending practices are much stricter today than they were in 2009. When the housing bubble burst, it triggered a lot of economic conditions that pulled us into a recession. Aside from this example, home values do very well during and after recessions, predominately because interest rates tend to drop, and that's a big spark for home values to increase.

Right now, we're still in a great housing market. Yes, home values have risen and with tight inventory, it can be challenging to find a home. But demographics remain strong. Looking at birth rate demographics and the average age of a first-time homebuyer, there will be more potential buyers entering the market in the coming years. With lingering supply chain issues, builders are not and will not be able to keep up with the rising demand.

Affordability issues are another hot topic the media is discussing. And while home prices have been rising, incomes have been keeping up. In addition, consider the alternative to buying. According to Apartment List’s National Rent Report for March, rents rose 17.1% year over year. If your clients choose to rent, the only person building wealth through real estate is their landlord. While buying a home might not be easy, there's still a great opportunity for your clients to be able to build wealth through real estate.

Do you want to benefit from analysis like this on a daily basis?

Investing in an MBS Highway membership – where you'll have access to tools like our Bid Over Asking Price, Buy vs. Rent Comparison, Loan Comparison tool, daily coaching videos, lock alerts and more – means you'll have everything you need to turn prospective homebuyers into clients and become the type of advisor they need to guide them in today's market and for years to come.

Take a free 14-day trial of MBS Highway and see for yourself how we can help you grow your business and benefit from the opportunities 2022 will bring.