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Five ways to tell if a slowdown will turn into a recession

Clifton Broumand has started noticing something is off at the trade shows.Since 1982, he's been selli...

Posted: Jan 2, 2019 1:12 PM
Updated: Jan 2, 2019 1:12 PM

Clifton Broumand has started noticing something is off at the trade shows.

Since 1982, he's been selling medical-grade keyboards and mice produced at his facility in Landover, Maryland, and he's been through a few recessions. Each time, he gets the feeling one's coming when foot traffic seems to be down at the exhibitions he visits to attract new clients.

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This year, he only got half the usual number of leads at an industry conference in Chicago. He knows what happens next.

"When you start seeing these things, it's like death by a thousand cuts," Broumand says. "You see a cut here, a cut there, and all of a sudden it adds up."

Most economic indicators aren't pointing to a downturn on the near horizon. But with seemingly constant chaos in Washington, recent turmoil in the markets and an expansion that's about to be the longest on record, businesses are getting nervous.

It's notably hard to predict recessions, which are only officially declared well after they've already begun. Eight months into the so-called "Great Recession" in 2008, many economists were still debating whether the economy was in fact in a recession.

The fact that the economy is strong right now is no shield against a recession. In fact, recessions typically start when the economy is at its peak and has nowhere to go but down.

Most economists expect slower growth in 2019, but the big question is whether that will morph into a full-blown recession — or if the Federal Reserve can successfully guide the US economy into a "soft landing," in which the economy slows but doesn't shift into reverse.

Every economist has their favorite advance warning system.

Business confidence

One indicator that tends to run well in advance of recessions: The National Federation of Independent Business measure of members' own subjective well-being, known as the small business optimism index. It peaked in the third quarter of 2004, while the American economy was growing faster than it is now, and then started falling until it bottomed out in early 2009.

More recently, the index spiked after President Donald Trump was elected, reached its highest reading ever in August — and has been sagging since.

Small business confidence is important because it can determine if those businesses will hire new workers and invest to grow the business, or if they'll start to pull back. And small businesses account for roughly half of the nation's economic activity.

Car sales

Bill Dunkelberg, chief economist of the NFIB, keeps an eye on intermediary businesses — anyone who takes orders directly from consumers, and could pick up on any hesitance in the sector responsible for 70% of gross domestic product.

"Car dealers are the ones who start to notice," Dunkelberg says. "When the car dealer isn't selling, he sends the message up to GM, 'I don't need the cars.'"

Motor vehicle sales typically take a turn for the worse at least a few months before recessions officially begin. But recently announced layoffs at GM notwithstanding, car sales have been hovering near historically high levels since early 2015.

Workers in the auto industry and other supply-chain roles see the signs of a slowdown becoming a downturn even earlier.

Worker hours

A recession may get rolling with a few seemingly anomalous events like the recently-announced GM plant closures. There can also be warning signs in large-scale buyouts, such as those offered to 10,400 Verizon employees a few weeks ago or FedEx buyouts due to a slowdown in trade amid global trade disputes.

But the more common first step is not being asked to stay late and come in on Saturdays.

"When manufacturing weakens, the firms wouldn't lay workers off, they would cut back their overtime hours," says economist Ed Leamer, who directs the UCLA/Anderson Business Forecast Project. So far, manufacturing workweeks remain very long by historical standards, after reaching their longest point since World War II in the spring of 2018.

Surprisingly, the low unemployment rate can help accelerate a slide.

The United States is at what economists consider full employment, with more job openings than workers seeking jobs. But employers unable to find the workers they want are more likely to turn to automation to do the work that they need done.

Rising wages, either because of market conditions or increases in minimum wage laws in many states, also makes increased use of automation more attractive. Another factor is the 2017 tax reform, which allows businesses a bigger tax cut on capital spending, such as robots and computer kiosks that can be used by customers, than on new hiring.

The trouble comes when the economy starts to slow, and it's the workers who are let go, not the machines.

That's why it can be just a matter of months for a labor market to go from very low unemployment to job losses and a recession, as happened in 2000 and 2001.

The housing market

Housing has historically been a harbinger of recession — most dramatically in the financial collapse of 2008, which was caused by a real estate bubble fueled by too-easy credit. This time may be different.

Home sales and residential investment have started to sag over the past couple of quarters. But there was no building boom, post-recession mortgage underwriting has been much more solid, and any drop-off in the housing market has been blamed on rising interest rates — as well as high home prices.

Still, home building and real estate accounts for a significant portion of the US economy and a slowdown in housing, for whatever reason, amounts to a slowdown in economic activity, even if it's not the catastrophe of the last recession.

Growing deficits

Michael Stritch, chief investment officer with BMO Wealth Management, says his clients are mostly concerned that ballooning government deficits may eventually force painful cuts in other areas and lead to political turmoil, even at a time of record corporate profits and low unemployment.

"We don't think it's going to be an acute problem unless people lose faith in the full faith and credit of the U.S. government," Stritch says. "It's likely to just eat away at potential GDP growth over time."

The rising federal deficits, about to crack $1 trillion for the first time, can result in higher interest rates, as the Treasury has to pay more to sell the bonds needed to fund the government. Rising corporate debt can have a similar impact on rates.

And the higher bond rates, coupled with the Fed setting its rates higher, can raise the cost of doing business, and the cost of living for households. That in turn serve as a brake on economic growth — especially if deficits are only used to finance tax cuts, rather than priorities like infrastructure and education that would generate a return on the investment over time.

Other pieces of the economy seem more likely to cause a slow drag than to suddenly crater and take the rest of the country with them. Tariffs, for example, have only started to increase prices in a few industries, which may eventually lead to lower orders.

Even though most analysts don't see major "imbalances" — or bubbles — in the real economy that would internally bring on a recession, every recession is a little different.

And this time, it's been long enough since the United States went through a serious downturn that a whole generation of business owners hasn't necessarily experienced one.

For Clifton Broumand, who's learned through hard experience how to prepare contingency plans as soon as it seems that business might disappear, the fading memories are cause for worry.

"A lot of people haven't lived through a recession before," Broumand says. "And this is the dangerous part. It's been such a long time, people might not be able to recognize the signs."

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