I ended the last “Bottom Line” talking about recession and its causes. I mentioned last time that it has been nearly ten years since our last recession. Wow! Think of that ten years of growth. Millions of jobs added, 401K’s growing at double digit speed, and overall personal wealth almost doubling. If the economy keeps growing for just 14 more months – which we expect that it will – it will become the longest expansion in United States history. Now that’s something. (Bloomberg February 6, 2018)
So the natural question is what could topple this great expansion? There are many possible causes of recession, so let’s explore some of those causes and see if we can see some warning signs. Here are 11 causes of recession identified by Kimberly Amadeo from The Balance.
1. High-interest rates. When rates rise, they limit liquidity, or the amount of money available to invest. The biggest culprit was the Federal Reserve, which often raised interest rates to protect the value of the dollar. The Fed raised rates to battle stagflation, causing the 1980 recession. It did the same thing to protect the dollar/gold relationship, worsening the Great Depression.
2. A stock market crash. The sudden loss of confidence in investing can create a subsequent bear market, draining capital out of businesses. Here’s how a stock market crash can cause a recession.
3. Falling housing prices and sales. As homeowners lose equity, it forces a cutback in spending as they can no longer take out second mortgages. Over time, it will cause foreclosures. This was the initial trigger that set off the Great Recession, but for different reasons. Banks that lost money on the complicated derivatives based on underlying home values.
4. A slowdown in manufacturing orders. Orders for durable goods started falling in October 2006, before the 2008 recession actually hit.
5. Massive swindles. The Savings and Loans Crisis caused the 1990 recession. More than 1,000 banks (total assets of $500 billion) failed as a result of land flips, questionable loans, and illegal activities.
6. Deregulation. The seeds of the S&L crisis were planted in 1982 when the Garn-St. Germain Depository Institutions Act was passed. This removed restrictions on loan-to-value ratios for these banks.
7. Over-regulation. When governments put too many or too punitive/restrictive regulations on industry it becomes too expensive for companies to do business and as a result it causes less completion, retards growth and that leads to layoffs and ultimately recession. This happened in the 1973-1975 recession with President Nixon’s wage and price controls and other fiscal regulations instituted at that time.
8. Slow down after a war. This caused both the 1953 recession, following the Korean War, and the 1945 recession, following World War II.
9. Credit crunch. This occurred when Bear Stearns announced losses thanks to the collapse of two hedge funds it owned. The funds were heavily invested in collateralized debt obligations. When Moody’s downgraded its debt, it, banks who were in a similar over-invested condition panicked. They stopped lending to each other, creating a massive credit crunch.
10. Asset bubbles: This is when the prices of internet companies, stocks or houses become inflated beyond their sustainable value. The bubble itself sets the stage for a recession to occur when it bursts.
11. Deflation, which encourages people to wait until prices are lower. This aggravated the Great Depression.
The number one indicator of recession is the inversion of the “Yield Curve” . this is when the short end or the shorter maturity treasury bonds (3 month – 2 years) have a higher yield than the longer end )10-30 year). 100 % of the time when the yield curve has inverted 12 to 18 months later we have had a recession.
What will be the culprit of our next recession and when will it happen? No one really knows for sure but it most likely will be a combination of the list above and it will be reflected in the yield curve.
The good news, currently I do not see any of these factors in play.
Next time in the “Bottom Line” What affects do Mid-term elections have on the stock market?
Your Boring Money Manager,
Mowery Capital Management
We manage risks first
Then we buy quality
And only then do we seek to provide a reasonable return
At the time of this writing:
Dow Jones 25,562.63
S&P 500 2,837.33
Two Year Treasury Yield 2.60%
Ten Year Treasury Yield 2.85%
Thirty Year Treasury Yield 3.02%
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Sources: The Capital Group. Zacks, Seeking Alpha, CNBC, CNBC guest and contributors, Jim Cramer, Wall Street Journal, Investor’s Business Daily, and Financial Times. Special thanks to Wikipedia and MarketWatch for historical facts. If I have inadvertently missed any other sources please accept my apologies. No assurance can be made that profits will be achieved or that substantial losses will not be incurred in connection with any investment. All investments involve varying degrees of risk including loss of capital. This information should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any individual investment or strategy. PAST PERFORMANCE IS NO GUARR ANTEE OR INDICATION OF FUTURE RESULTS
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