Fundamental Indicators

The Typical Business / Recession Cycle

Recessions are typically brought on by one of two events: they are intentionally induced by the Fed through rising rates, or they are triggered by credit shocks to the economy outside of the Fed's control.  Sometimes they're the result of both occurring in unison.  (Those ones aren't good.)  A typical Fed induced recession will be evident in an inverted or flat yield curve, while a credit-shock induced recession will be evident in a sharp spike in lending rates and interest rate spreads.

As a recession begins, demand subsides and is reflected as a stabilization and then drop in capacity utilization.  Also expect to see a peak in the Purchasing Managers' Index (PMI) followed by a steady decline.

As the recession gains momentum, workers start being fired en masse.  This is clearly visible in the rising trend of initial claims:

In normal times recessions are intentional and brought on by the Fed raising rates to cool off the economy and prevent excessive inflation.  Eventually the fed will begin to lower rates to provide support for the weakening economy though.

As a recession comes to an end (but prior to the start of a recovery), the pace of firings should peak and begin to slow:

Soon after we should see a rise in the PMI as inventories are restocked and purchasing managers prepare for the eventual recovery:

As the recovery begins, we should see an uptick in temporary employment.  We should also see improved conditions for those that managed to keep their jobs throughout the recession (average number of hours worked per week should begin to rise, and we should see an increase in earnings and overtime hours worked as well):

As the recovery gains momentum, we should see a rise in job openings and new hires, which will ultimately manifest themselves as a drop in unemployment.

Once the Fed believes the economy is stable enough to stand on its own two feet again, they will begin to once again raise rates and start the cycle all over:

Additional Charts

Mr Bond is very keen and often makes recession calls with uncanny precision (reflected as an inversion of the yield curve).  If you're interested in stocks, you should keep your eyes on the bond market as it often leads the stock market in major trend shifts.  A steep yield curve encourages growth while a flat yield curve discourages it.

Recessions brought on my credit shocks will be easily seen in a sharp rise in spreads (LIBOR-OIS and TED are our favorites) and interbank lending rates:

Don't Forget Sentiment

Sentiment acts as a great contrary indicator, though it is tricky to trade because sentiment can remain at extremes longer than you can stay patient.  The AAII Bull/Bear Ratio is a great one to keep an eye on:

The AAII Asset Allocation indices are also great contrary indicators when they reach extremes: