If you’ve followed financial headlines over the past few months, it seems like everyone with an MBA thinks a recession is coming.
Economists peg the odds that a recession will occur in the next 12 months at 61%, according to the most recent Wall Street Journal poll. That’s no guarantee, but if you heard there was a 6 in 10 chance your house would flood, you’d at least start packing up the basement, right?
That’s what corporate CEOs are doing. Some 93% of them report that they’re preparing for a recession over the next 12 to 18 months, per a recent survey from the Conference Board.
Investors, however, don’t seem to have gotten the memo, as the S&P 500 index is up more than 10% so far in 2023.
It’s just another data point in an economy that’s in a profoundly strange and confusing place. Although many think the economy is heading for a downturn, we still have strong employment, robust consumer spending and a rising stock market.
“To say that this is a unique cycle is stating the obvious, but in terms of the nature of where we are in the cycle, there really is no historical comparison,” says Liz Ann Sonders, managing director and chief investment strategist at Charles Schwab.
Here’s what she and other pros make of the current economic climate, and how they say you should consider preparing for what lies ahead.
Making sense of a confusing economy
The definition of a recession is loose, but generally, economists define it was two consecutive quarters of negative growth in the economy. Generally, a recession is accompanied by high unemployment, a dip in consumer spending and a drawdown in the stock market.
The official arbiter of recessions, the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
A decline in economic activity is exactly what the Federal Reserve wants. Over the past year and change, the central bank has rapidly raised short-term interest rates as part of an effort to cool the economy and, in turn, tamp down rampant inflation.
But the Fed is walking a tightrope. Slow things down too much, and the economy could tip into a recession.
So far, an economy-wide downturn hasn’t happened yet. But some things feel distinctly recession-like. Maybe you’ve caught news that high-profile companies have conducted mass layoffs of late. Or seen headlines heralding the largest bank failures since 2008. Or maybe you’ve noticed that the yield curve has long been inverted — a classic recession indicator.
Meanwhile, other aspects of the economy, such as a low unemployment rate and robust consumer spending, indicate all systems go.
The mixed signals can be chalked up to what economists describe as “rolling recessions.”
“Many of the businesses that launched us out of the Covid recession have since gone into their own recession,” says Sonders.
Put broadly and simply, during the shutdowns, the service side of the economy wasn’t available, so consumers flocked to goods. Once things opened back up, consumers returned to services, leaving some of the pandemic beneficiaries — single-family homes, consumer goods, work-from-home companies — in the dust.
“We’ve had recessions in those pockets of the economy, but offsetting strength in services,” Sonders says. “We’ve seen strength and weakness roll through the economy, thereby not having the bottom all fall out at once.”
How to prepare for what comes next
The million-dollar question: Is the U.S. economy going to sink into a recession?
It’s impossible to say, of course, but one thing is for sure, says Ed Yardeni, an economist and president of Yardeni Research. “If we do have a recession, it will be the most widely anticipated recession of all time.”
“Usually, recessions kind of surprise everybody, and everybody is stuck with a lot of business that was built on the assumption of growth for the foreseeable future. And then suddenly the floor falls out from under them,” he says.
Given that just about every CEO in the country is battening down the hatches to some extent, that’s unlikely to happen. But stock investors could still be in for some pain. Although the market has been trending upward, some of the biggest companies have been doing the heavy lifting while many others lag — a classic sign of market weakness, says Sonders.
What’s more, while market-watchers seem to believe the Federal Reserve will pause its interest rate hikes, the market seems to be pricing on the assumption that rates will soon come down. But such a move by the Fed would only happen “with an economic backdrop that is much uglier than what we’re looking at right now,” says Sonders.
In other words, the only way the Fed would begin lowering interest rates at this stage is if the economy hit the skids. “Something’s gotta give in terms of investor expectations,” Sonders says.
Where does that leave you and your portfolio? Experts say to expect volatility, but not to let short-term shakiness in the markets cause you to shift your long-term plans.
“It’s appropriate to exercise a little bit of caution in [stock] markets,” says Gargi Chaudhuri, head of iShares investment strategy, Americas, at BlackRock. “But at the same time, we tell investors to stay invested for the long-term. So how do you do both?”
Within your stock portfolio, Chaudhuri recommends focusing on so-called high-quality companies — those with strong balance sheets, expanding margins and that have displayed resilience in past economic downturns.
Sonders, who also recommends a shift to quality stocks, prizes firms with ample cash flow to fund operations without taking on debt and recent history of beating earnings estimates.
The same logic applies to bonds, where analysts recommend a focus on debt with high credit ratings that are unlikely default, including Treasurys and investment-grade corporate debt.
“Look for more defensive areas of the market that let you stay invested, but at the same time, protect you a little bit as the market continues to experience volatility,” says Chaudhuri.
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