The decision to buy or sell a home doesn’t happen in a bubble. You can follow all the right steps to prepare yourself financially for investing in residential real estate, but there’s still the larger economy to consider. What the economy is doing at a macro level can have huge effects on the real estate market.

In the interest of educating our clients, we’d like to provide some insight into the economy and markets — how they work, what they’re doing, and how they affect you. 
We sat down recently with our friend Dan Dillard of NEST Financial, a local Austin wealth management firm. The NEST team has decades of diverse experience handling everything from personal financial planning to active investment portfolio management — and yes, they’re total finance nerds. Financial education is the cornerstone of what they do, which is why we’re so glad to get their take on all things economic.

In this post, we’re talking recession.

Inflation is at its highest rate in 40 years, interest rates are going up, and the economy is slowing down. Signs point to a great possibility of a recession on the horizon. 
But what exactly is a recession? What causes them? How do you know if you’re in one?

WHAT IS A RECESSION?

Dan: A recession refers to a time of significant economic slowdown at a macro level. Its effects reach all areas of the economy.

The economy is constantly fluctuating. It gyrates. It has its ups and downs. So, just because the economy is slowing down, it doesn’t mean we’re in a recession. Technically, an economic contraction has to last for a few months, and by some definitions two quarters, to be a recession. And even then, it only becomes “official” when NBER (the National Bureau of Economic Research) says it is. By the time they get the data they need to make it official, we’ve already been in a recession for months. It’s not up-to-the-minute.

But, you can certainly read the signs if you’re looking.

Recession is one of the stages in the business cycle. As an extended contraction, lots of things contract right along with the economy. Production slows. Stocks fall. The GDP shrinks. Businesses and banks are more likely to fail. The only things not contracting are the national debt and the unemployment rate.

But as NEST’s investment manager, Sean McDougle, stresses, there are opportunities in every economic environment. That’s why one of our core strategies is to constantly monitor the global economy at a macro level. This allows us to adjust our portfolios into more secure and even profitable investments.

The same is true for real estate investments, whether you’re looking to buy, sell, or invest. There are opportunities if you know where to look.

WHAT EXACTLY IS THE BUSINESS CYCLE?

Dan: The business cycle basically describes how the economy is doing. It’s a cycle because the economy isn’t static. Things are always growing, shrinking or at a high or low point in between. The business cycle consists of four different stages — expansion, peak, contraction, and trough.

The interesting thing is that, because the data is always delayed, it’s impossible to know beyond a doubt which stage you’re currently in, especially peaks and troughs. And when the numbers  finally do come out, you may have already moved into the next stage of the cycle.

The good news is there are indicators that can help you make an educated guess in real-time.

WHAT ARE THE INDICATORS OF EACH STAGE IN THE BUSINESS CYCLE?

Dan: First we have expansion. During the expansion phase of the cycle, the economy grows. Interest rates are usually low, production is high, along with inflation. Things might feel too good to be true for a while, because they are. A peak is coming, and once you peak, there’s only one way to go.

Some indicators of an expansion are low unemployment, high supply and demand of goods, income and wages going up, and more investments in equities.

When expansion reaches its apex, it’s called a peak. During a peak, economic growth has maxed out. Like a rollercoaster car summiting the peak of the first big hill, things will soon start to drop — growth, inflation, production. Essentially, the economy begins to correct some of the imbalances created by rapid expansion. The peak of a cycle is reached when growth hits its maximum rate.

You’ll know you’re near a peak when you see peak prices, economic growth slowing, and demand for goods is very high. But toward the end of the peak, you’ll start to see reversals of expansion indicators.

Once we’ve gone over the peak, we enter a contraction. The economy begins to correct itself after the ballooning of the expansion period. Growth slows, prices stagnate, and employment falls. One of the first casualties of recession is, unfortunately, jobs. This is a time when a lot of companies begin to tighten their belts, and that can mean layoffs.

A contraction that lasts over a few months is a recession. A prolonged recession is a depression. We haven’t had one of those since the Great Depression.

Some indicators that we’re in a contraction are decreased demand for goods and services while the supply remains high, prices dropping, unemployment going up, and wages going down.

The final stage in the cycle is the trough. This is the rock-bottom of the contraction. On the bright side, once it bottoms out, the economic upswing begins, and we enter a new phase of recovery and expansion.

You’ll see things at their worst — economic growth is at its lowest, supply and demand are both down, and unemployment rates are high.

WHAT CAUSES RECESSIONS?

Dan: Economies have so many moving parts, which means there are a lot of things that can lead to recession. First, sudden economic shocks that affect the US or global economy. Covid is a good recent example of that. Another is excessive debt. That includes both businesses and individuals. We saw that in the housing crisis of 2008. Recessions can also be caused by asset bubbles from overly-optimistic investors who end up inflating the stock market or creating real estate bubbles.

Then there’s inflation, which is probably sounding pretty familiar right now. Now, inflation is pretty much always happening. But at times it happens too quickly, and prices get out of control. To combat this, the Fed raises interest rates. Sometimes this technique is a little too effective, and it can start a recession.

Rapid deflation, technological progress, and other things can also lead to recessions.

ARE WE IN A RECESSION NOW?

Dan: As of right now, we aren’t officially in a recession. However, if you look you can see a lot of the indicators that we’ve peaked and one could be coming — inflation is very high, the Fed raised interest rates, personal debt is up, etc.

Obviously, no one can predict the future, but there are things you can do to prepare should a recession be on its way. We’ve actually written about this recently on our website. But wherever in the business cycle the economy is, you should strive to understand the characteristics of each stage and how to best prepare for and optimize your finances and investments during them.