Should You Fear This Recession Warning Signal?

By Markets Fool.com

Do you feel wealthy?

Continue Reading Below

While Americans are in a very privileged position relative to most of the world when it comes to wealth and income, a recent Credit Suisse report shows that inequality is rising. The wealth-to-income ratio, which tracks the amount of wealth (assets like housing and investments) relative to incomes, is rising -- meaning that those who are already wealthy are getting wealthier, while those reliant on incomes aren't.

Their disturbing conclusion? That regardless of what you think about income inequality, we should be concerned: the ratio has a tendency to spike just before recessions, and the relationship is pretty frighteningly consistent.

It's spiking now -- so should we be preparing for another recession?

Rising asset wealth and stagnant wages
There are a few possible drivers for the change in the wealth-to-income ratio, which usually stays in a pretty consistent range in the United States.

The first order of business is to figure out what could be driving gains in wealth. Two big factors are housing and the stock market -- as each market rises, property or paper wealth grows accordingly.

Continue Reading Below

How can that lead to a recession? Things can go wrong if the growth fuels a bubble, which we're all familiar with. Housing prices start to go up, so people jump into the market, so prices keep going up, and so on. Thus, asset bubbles might be one of the main forces that contributes to the ratio's relationship to recessions.

Also relevant is the story of income. When adjusted for inflation, incomes for most Americans have been pretty stagnant for decades, while income growth at the top of the income ladder has been breathtaking.

A lot of income concentrated among the wealthy could cause a lot of money to be plowed into assets such as houses and investment accounts -- you see where this is going. After all, much as many people try, you can't really spend everything.

So does this mean a recession is on the way?
We haven't seen an equivalent of the madhouse stock market returns, "new world order" dot-com hysterics, or the wave of career changes into "housing investment" that characterized the three recessions that were preceded by a much higher wealth-to-income ratio.

What we do have is several years of really loose monetary policy, which sparked a search for yield that pushed up the prices of high-yield bonds into uncharted territories. We have an S&P 500 that's returned 44% since the end of 2012. And we have falling oil prices, which could move the stock market up even further.

There's still some debate, of course, about whether any or all of this constitutes an asset bubble. The question is whether any or all of it is sustainable, and I think the reasonable answer is "no."

Will high-yield bonds always produce relatively low yields? No, they can't, so when yields go back up, it means that eventually prices will go down. Will the S&P 500 keep rocketing forever? No, even if you don't take into account the probability that oil prices won't stay low forever.

The question is how big the "bubble" is and when and how it'll go south. Nouriel Roubini, who famously predicted the Great Recession, is so sure that things will crash that he's said the next recession will start in 2016.

It is, of course, an impossible task to predict the future, but the features of an asset-fueled recession are, one must admit, all there. Maybe the Fed can discourage the bubble from getting out of hand, thus heading a recession off at the pass, or maybe it'll be a slower and gentler transition than Roubini imagines.

Either way, what goes up must, eventually, come down, and, based on the wealth-to-income ratio and the characteristics of the market, that's looking like a very real prospect.

The article Should You Fear This Recession Warning Signal? originally appeared on Fool.com.

Anna Wroblewska has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.