What Really Causes Recessions (And How to Prepare as a Rule #1 Investor)

There's a lot of speculation that another recession is on the horizon.

You may ask...

Are these speculations true?

Will my family be affected?

What will happen to my stocks and my money?

Understanding the underlying factors behind what causes a recession can be a critical factor in avoiding losses.

It’s not news to anyone that the U.S. stock market has had quite a few good years. It actually was in the longest bull market in American history. So, we are due for a recession. In order to make accurate predictions concerning another recession, you must be aware of the factors that can cause one.

What Really Causes Recessions?

At the core, most recessions over the last 140 years have been driven by the credit cycle. In a strong economy, individuals and businesses borrow money to fuel growth. As optimism grows, borrowing increases — often beyond sustainable levels. Eventually, either lenders tighten standards or borrowers hit their limits, leading to reduced spending, lower income, and widespread economic contraction.

The Federal Reserve plays a crucial role in this process. When it senses the economy overheating, it raises interest rates to curb excessive borrowing and inflation. However, rising rates can also trigger a downturn by making it harder for consumers and businesses to afford debt payments, eventually tipping the economy into recession.

Key Recession Indicators to Watch For:

• Rising interest rates

• Slowing retail sales

• Increasing personal and corporate debt

• Declining manufacturing output

• Falling GDP over two consecutive quarters

• Tightening job markets despite labor shortages

By understanding these indicators, investors can better prepare for opportunities when the market turns.

Even when Warren Buffett talks about it he says,

"We shouldn't have the kind of debt we've got, with unemployment rates where they are, with inflation rates very low, and the Federal Reserve lowering interest rates."

That just doesn't compute in any of Warren Buffett's time on the planet.

The Federal Reserve’s recent policies have been historically unusual. Despite very low unemployment and very low inflation, the Fed has kept interest rates artificially low for years - until recently, encouraging high levels of borrowing. According to Warren Buffett, this environment of massive debt combined with ultra-low rates "doesn’t compute" with any historical precedent​.

This has created a fragile economic situation where even small increases in rates can have outsized impacts on borrowing, spending, and corporate profitability — making a recession more likely.

Why a Recession is a Buying Opportunity for Rule #1 Investors

If you're prepared with a watchlist, because you've learned how to invest, you have a list of great businesses you want to buy.

Preparing for Opportunities During a Recession

During downturns, not all companies are equally impacted. Businesses with strong pricing power, durable competitive advantages (wide moats), and low debt tend to perform best through recessions and inflationary periods​.

Focus on companies that:

• Can pass increased costs to customers without losing sales.

• Have strong cash flow even during tough economic times.

• Are essential to everyday life (e.g., healthcare, utilities, consumer staples).

• Have a history of thriving during inflationary periods.

By concentrating on these types of businesses, Rule #1 investors can turn a market crash into an incredible buying opportunity.

The coming, inevitable recession is going to be an opportunity for you to swoop in and buy these businesses on sale. Then, when the market rebounds, your investments will become very profitable.

The principles of Rule #1 Investing teach that identifying value is critical so that you know when it's an opportunity to buy a great company on sale. It's the way you can find the best deals on buying wonderful businesses and take advantage of a recession when everyone else is panicking.

Do you think we’re headed for a recession? This Stock Market Crash Survival Guide will help you prepare for the next market crash and help you cash in when the market drops!

**Editor’s Note (Updated April 2025): This article was originally published in 2019 and has been significantly updated in 2025 to reflect current examples and Rule #1 investing insights.