{"id":96983,"date":"2016-10-26T11:23:58","date_gmt":"2016-10-26T15:23:58","guid":{"rendered":"http:\/\/countingpips.com\/?p=96983"},"modified":"2016-10-19T11:24:31","modified_gmt":"2016-10-19T15:24:31","slug":"8-economic-indicators-that-may-predict-recession","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2016\/10\/8-economic-indicators-that-may-predict-recession\/","title":{"rendered":"8 economic indicators that may predict recession"},"content":{"rendered":"
October 26, 2016<\/div>
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By Admiral Markets<\/b><\/p>\n

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Dear traders,<\/p>\n

By definition, economic recession is a period of at least two consecutive quarters when the economy is in decline.<\/p>\n

It is typically accompanied by an increase in unemployment, decline in the housing market and a drop in the stock market \u2013 decline in GDP.<\/p>\n

Though recession is less severe than a depression, there are still many different factors that are the cause of recession.<\/p>\n

While many economists and some traders are arguably versatile in predicting another recession, beginner traders can have difficulties deciding which factors to track.<\/p>

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Can we predict recessions?<\/p>\n

The short answer is, yes \u2013 I personally think it is possible, at least to a large extent.<\/p>\n

Now, let’s talk about the key economic indicators when trying to predict the next recession and how to use this information when trading.<\/p>\n

Yield curve<\/h2>\n

This is my favorite economic indicator.<\/p>\n

So, how to predict recession with a yield curve?<\/p>\n

I will try to explain it in an easy way.<\/p>\n

In normal markets, a longer-dated bond should have a higher yield than a shorter dated bond.<\/p>\n

If we take a look at US government bonds<\/a>, we can see a normal yield curve that has rising yields with longer duration.<\/p>\n

Risk premium<\/h3>\n

Longer-dated treasuries or bonds in a normal or positive yield curve means they attach a higher yield than shorter maturing treasuries or bonds.<\/p>\n

This is caused by a risk premium.<\/p>\n

This risk premium considers the possibility that rates may increase in the future.<\/p>\n

Consequently, longer-dated treasuries of bonds might have a higher yield than shorter-dated ones.<\/p>\n

Normal yield curve<\/h3>\n

<\/p>\n

Duration is the bond’s time to maturity.<\/p>\n

So as duration increases, the yield increases with it.<\/p>\n

The implication of a normal yield curve is that the longer the bond duration, the higher the yield.<\/p>\n

Inverted yield curve<\/h3>\n

<\/p>\n

An inverted yield curve is usually a sign of recession coming.<\/p>\n

This is due to people flocking to longer-dated bonds for safety of returns, causing the price of bonds to rise and the yields to drop.<\/p>\n

As longer-dated bonds attract a premium in price, a lower yield may imply that rate cuts are in the near future.<\/p>\n

In simple terms, an inverted yield curve can imply a future recession, as it indicates that shorter-term yields are lower than longer-term yields.<\/p>\n

This also means that interest rates in the near future will reduce.<\/p>\n

<\/p>\n

GDP<\/h2>\n

Gross domestic product (GDP) is the market value of all goods and services produced within a country in a given period of time.<\/p>\n

In economic terms, if GDP declines for two or more consecutive quarters, it is a sign of recession.<\/p>\n

Oil supply<\/h2>\n

Oil supply is directly linked to GDP.<\/p>\n

Higher oil prices increase the cost of production of most goods and services, with a chance to cause lower real GDP and higher inflation.<\/p>\n

As a consumer, you may already understand the lesser implications of higher oil prices.<\/p>\n

To better illustrate it, I will use gasoline example.<\/p>\n

Gasoline purchases are necessary for most households.<\/p>\n

When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services.<\/p>\n

Similarly, higher oil prices tend to make production more expensive for businesses, leaving them less assets to invest into other fields.<\/p>\n

High interest rates<\/h2>\n

When interest rates rise, they limit the amount of money available to invest.<\/p>\n

In the recent history, the biggest culprits was the Federal Reserve, which would often raise interest rates to protect the value of the dollar.<\/p>\n

The Fed also raised rates to protect the gold vs. dollar relationship, which made the Great Depression even worse.<\/p>\n

Asset bubbles<\/h2>\n

When the prices of different companies, houses or stock markets become inflated beyond their sustainable value, they tend to burst.<\/p>\n

That’s why we call it “the bubble”.<\/p>\n

Recession usually occur when the bubble bursts.<\/p>\n

Stock markets and currency correlation<\/h2>\n

The drop in stock markets may also predict recession.<\/p>\n

The sudden loss of confidence in investing can create a subsequent bear market, which may drain the capital out of businesses.<\/p>\n

Keep in mind that if loans are written off as bad, it actually destroys the supply of the currency…<\/p>\n

…which may cause the currency to strengthen too.<\/p>\n

Money supply and velocity<\/h2>\n

Money velocity is the amount of times that money is turned over in a given period.<\/p>\n

So when money velocity is high, it means there is a lot of transactions, which is good for economic activity.<\/p>\n

Consequently, a drop in money velocity can be a sign of an impending recession.<\/p>\n

Here is a good article<\/a> explaining money velocity in the credit crunch and recession.<\/p>\n

Technical chart<\/h2>\n

<\/p>\n

The chart above shows the Dow Jones during the two most recent recessions that happened in the last 15 years.<\/p>\n

The first one is the small recession after dot-com bubble and the second one is the recession linked to the global financial crisis<\/a>.<\/p>\n

My personal study has shown that the only lead you get from the stock market is if a significant high is made.<\/p>\n

Then, the equities market should keep going lower into the recession.<\/p>\n

In both cases, the index price went below the 200 SMA on Weekly TF.<\/p>\n

Best Forex indicators for this purpose are 200 SMA plotted on weekly chart, zoomed out with trend line overlay and MACD<\/a>.<\/p>\n

In the picture above, we can see that the first economic downturn started in early 2000s.<\/p>\n

This coincides with the collapse of the speculative dot-com bubble and September 11 attacks.<\/p>\n

Dow Jones Index dropped significantly.<\/p>\n

The subprime mortgage crisis led to the collapse of the United States housing bubble, lasting from December 2007 until June 2009.<\/p>\n

It was named the global financial crisis.<\/p>\n

Have in mind that recessions usually run their course over time, but the major goal is to make sure that they do not cause a depression.<\/p>\n

How to make money during recession and depression<\/h2>\n

This is what traders should watch for if they want to trade during recession\/depression:<\/p>\n

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  1. abovementioned economical signs and cues<\/li>\n
  2. weekly timeframe for spotting out technical patterns<\/li>\n
  3. lower timeframes for cherry-picking overbought price<\/li>\n
  4. traders should be following the trend by selling the equities.<\/li>\n<\/ol>\n

    Weekly time frames and monthly charts will provide traders with complete look of the price action.<\/p>\n

    Once the price breaks below trend lines like the 200 SMA with MACD being below 0 line, traders should focus on lower time frames to find better entries.<\/p>\n

    H4 or Daily time frame have the least noise so they could be suitable for cherry picking the entries.<\/p>\n

    As with all bearish trends, traders should sell when the price is overbought. If US gets into recession again it would be mainly US equities<\/a>.<\/p>\n

    You have to remember, US Economy is largest in the world, and can drag the rest of the world into a recession.<\/p>\n

    Equities are generally positively correlated, so they tend to fall together in most cases.<\/p>\n

    Outside US Equities, it is likely to impact the Import partners most.<\/p>\n

    …China, Canada, Mexico, Japan and Germany in that order\u2026<\/p>\n

    …and their respective Indices.<\/p>\n

    <\/p>\n

    This unique correlation table<\/a> shows dynamic correlation between equity markets.<\/p>\n

    In a nutshell<\/h2>\n

    Inverted yield curve, reducing money supply and reducing money velocity all point to a possible recession.<\/p>\n

    Once everything is set in motion, a domino effect prevails, with one outcome causing or worsening another.<\/p>\n

    When the stock market becomes unstable, businesses become fearful and lay off more workers, leading to greater unemployment.<\/p>\n

    This vicious cycle generally continues for months.<\/p>\n

    Technical charts give us a clear picture, with zones and levels where we could place our trade setups.<\/p>\n

    For some traders, effects of economic recession can even be beneficiary.<\/p>\n

    Have you ever traded during recession and\/or depression?<\/p>\n

    Feel free to let us know in the comments below.<\/p>\n

    Cheers and safe trading,<\/p>\n

    Nenad<\/p>\n

    \"Zero<\/a>
    \nArticle by Admiral Markets<\/b><\/p>\n

    Source: 8 economic indicators that may predict recession<\/a><\/p>\n

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    <\/a><\/p>\n

    Admiral Markets is a leading online provider, offering trading with Forex and CFDs on stocks, indices, precious metals and energy.<\/p>\n

     <\/p>\n","protected":false},"excerpt":{"rendered":"

    By Admiral Markets Dear traders, By definition, economic recession is a period of at least two consecutive quarters when the economy is in decline. It is typically accompanied by an increase in unemployment, decline in the housing market and a drop in the stock market \u2013 decline in GDP. Though recession is less severe than […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-96983","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/96983","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=96983"}],"version-history":[{"count":3,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/96983\/revisions"}],"predecessor-version":[{"id":96988,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/96983\/revisions\/96988"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=96983"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=96983"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=96983"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}