History Says This Recession Indicator Is Almost Never Wrong. Here's What It's Saying Right Now.

After a year of record-breaking gains, the market's tides may be turning. As of this writing, the S&P 500 (SNPINDEX: ^GSPC), Dow Jones Industrial Average (DJINDICES: ^DJI), and Nasdaq Composite (NASDAQINDEX: ^IXIC) have slipped around 2%, 3%, and 5%, respectively, from their highs earlier this year.

Investor sentiment is also stumbling. The Fear and Greed Index measures investor sentiment on a scale from 0 to 100, with lower values indicating fearful investor behavior and higher figures suggesting greed. As of this writing, the index sits at just 32 -- well into the "fear" category.

We know that a downturn is bound to happen sooner or later, as no bull market can last forever. But are we on the verge of a recession right now? Here's what the data says.

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A nearly flawless recession indicator

The yield curve is one of the most well-known and reliable recession indicators. It inverts when long-term interest rates fall below short-term rates, and an inverted yield curve has preceded nearly every recession since the 1970s.

The 10-year-to-two-year spread is the curve most analysts watch as a recession indicator. Ahead of the dot-com bubble, this curve inverted in February 2000. Just one month later, the dot-com bear market officially began. It inverted again in 2006, and by late 2007, the U.S. was descending into the Great Recession.

Most recently, the yield curve inverted in 2022. While we technically didn't experience a recession that year, stocks fell into a bear market amid economic strain marked by runaway inflation and repeated interest rate hikes by the Federal Reserve.

10-2 Year Treasury Yield Spread data by YCharts

Right now, the yield curve is not inverted and hasn't been since 2024. But it is sloping downward, and with more interest rate hikes on the table from the Fed, it's uncertain how it will fare going forward.

To be clear, no recession indicator will be 100% correct. Even the more accurate ones can't predict when a downturn will begin, how long it might last, or how severe it might be. That said, history says that it's simpler than you might think to prepare for a potential recession.

How investors can prepare for a recession

We're bound to face some sort of downturn eventually, as recessions are a normal part of the market's cycle. So rather than getting caught up in when it might happen, it's wise to start preparing for the inevitable slump.

Perhaps the best move investors can make right now is to ensure they're only buying quality stocks from healthy companies. Robust fundamentals -- such as a durable competitive advantage and healthy finances -- separate strong stocks from weak ones, as they're the difference between a stock that bounces back after a recession and one that crashes and burns.

^SPX data by YCharts

It's unclear where the market is headed in the coming months, but even if we do face a recession, strong stocks will recover with enough time. Since January 2000, for example, the S&P 500 has surged by more than 750%, despite multiple historic bear markets in that time.

By investing in healthy stocks built on solid foundations, your portfolio is much more likely to survive even extreme volatility and deliver positive total returns over time.

Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.