The economy operates in cycles. Usually, the economy will expand for a few years before growth slows down and eventually even starts to contract. Once the economy starts to contract, we are said to be in a recession, or potentially even a depression. Layoffs, market declines, and other turbulence can occur any time, but the risks are especially high during a recession.
As such, watching for signs of a recession is vital. Of course, even the best-trained economists can’t predict exactly when a recession will occur. Still, there are some things you should look for. Obviously, if GDP readings suddenly turn into the red, the economy is already contracting, but at that point, it’s probably too late to prepare.
One of the most important signs of a recession occurring is the build up a bubble. If things seem too good to be true then you should keep your eye out. Things seem obvious in hindsight, but if you look at the Internet bubble in the 1990s, it now seems pretty obvious that companies that can’t even come close to producing a profit are not worth millions upon millions of dollars. So, ask if demand is actually sufficient and if the market makes rationale sense.
You should also keep a close eye on consumer confidence levels. In many ways, average citizens are just as good at predicting economic trends as economists. They have ears to the ground and if consumers are starting to take a negative outlook, it might be because things are genuinely heading south.
Trends in Purchasing Management Indices (PMI) are also important to watch. A PMI reading is a survey of industry data. For example, the PMI reading for manufacturing measures inventory levels, new orders, supplier deliveries, production and the employment environment. A reading above 50 means the sector being measured is expanding, below 50 and it is in contraction.
Obviously, knowing the performance of these factors can illuminate a lot about the economy. For example, if new orders are dropping then it might be because the economy is slowing down. Meanwhile, if production is dropping, it could be because companies are preparing for an anticipated future drop in demand.
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