Determining a Recession: The Rearview Mirror vs. Windshield
“Recession” is a term used to describe a period of economic downturn characterized by declining economic activity, reduced consumer spending, and a decrease in overall economic growth. Whether we are in a recession is often a subject of debate, and the answer is not always clear.
The problem with determining if we are in a recession is that by the time we call it, we may already be out of it. Assessing whether we are in a recession is like driving a car—you can look through the rearview mirror or out the windshield. Both perspectives are important, but neither gives the whole picture.
The Rearview Mirror Approach
The rearview mirror approach to determining a recession is based on backward-looking indicators, such as gross domestic product (GDP) and unemployment rates. These indicators can provide valuable insight into the state of the economy at a certain point, but they are snapshots in time and may not accurately reflect the present or future.
One of the main issues with this approach is that it is based on historical data, which may not accurately reflect the current or future state of the economy. For example, a decrease in GDP in the past does not necessarily mean the economy is in a recession.
Another challenge with the rearview mirror approach is that data may take several months or even longer to become available. The National Bureau of Economic Research (NBER) is the organization that officially declares when a recession has begun and ended. The NBER’s determination is based on a review of the available data, including GDP, employment, and other indicators. However, this process can take several months, and by the time the NBER declares a recession has occurred, it may already be over.
The Windshield Approach
The windshield approach to determining a recession focuses on forward-looking indicators, such as consumer confidence and business sentiment.
This approach takes into account the current state of the economy, as well as factors that may impact the future. For example, a decrease in consumer confidence may indicate that consumers are becoming less willing to spend money, which could lead to a slowdown in the economy.
The windshield approach to determining if we are in a recession has its limitations and challenges. One of the main issues is that forward-looking indicators are often based on predictions and assumptions, which can be subject to error.
For example, consumer confidence can be affected by various factors, such as political events, natural disasters, and changes in the stock market. If these events occur, they can cause a sudden decrease in consumer confidence, which may not accurately reflect the future state of the economy.
Another challenge with the windshield approach is that forward-looking indicators may not be available in real time, which can make it difficult to make timely and accurate forecasts about the future state of the economy.
What Can You Do?
Uncertainty about whether we are in a recession can cause anxiety for many people. This anxiety can lead to emotionally based decisions, such as panic-selling investments, which can result in significant financial losses.
To avoid this, you may find a long-term financial and investment plan helpful. If you are close to retirement, it is especially important to have a solid plan to help ensure your retirement savings are protected. A fiduciary financial advisor can help you create a plan tailored to your specific needs and goals.
You might also:
Diversify your investments: Diversifying your portfolio across different asset classes, such as stocks, bonds, and other investments, can help reduce the impact of a recession on your portfolio. Consider working with a financial advisor to determine the right mix of investments for your situation.
Build an emergency fund: An emergency fund can help weather financial shocks during a recession. Aim to have three to six months’ worth of living expenses saved in a liquid, low-risk account, such as a high-yield savings account.
Avoid making impulsive decisions: Economic uncertainty can lead to anxiety and fear, which can drive impulsive financial decisions. Try to stay calm and avoid making any major financial moves based solely on emotions.
Stay informed: Stay informed about economic trends and changes in the market, but be mindful of sources that may be sensationalizing or spreading false information.
Final Thoughts
Determining if we are in a recession is a complex process that requires understanding both backward-looking and forward-looking indicators. It is important to remember that by the time we know we are in a recession, it may already be over.
To avoid making emotionally based decisions, you can create a long-term financial and investment plan. If you do not have a plan or think your plan needs adjusting, consider working with a financial advisor. A financial advisor can help you create and implement a financial plan while coaching you through uncertain times.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was generated using artificial intelligence (ChatGPT) and edited by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.