Analysts at the mutual fund giant Vanguard estimate the likelihood that the U.S. will drop into a full-blown recession sometime during the next 12 months at 25%, and some time during the next 24 months at 65%.
The Vanguard analysts aren’t alone.
A SmartAsset survey of nearly 300 financial advisors taken in early August found that 80% believe the U.S. either is already in a recession or will enter one during the next 12 months. A rough rule of thumb to define an economy in recession is when it records two straight quarters of declining economic growth. For the second quarter of 2022, the country’s gross domestic product (GDP) fell by 0.9% after a contraction of 1.6% for the first quarter.
But many believe it takes more than just negative growth to constitute a recession.
For help understanding what a recession is and how to strategize your investments to navigate a down market, consider working with a trusted financial advisor.
Is a Recession Coming?
Other factors also are part of whether an economy is in a recession. They includes employment, which has remained high despite the GDP figures, with a jobless rate of 3.7% for August, a level well below the 5% unemployment rate economists have traditionally considered full employment. In addition to adding more than half a million jobs, inflation stalled between June and July. Since then, gas prices have fallen, housing prices have dropped and consumer spending has remained strong.
Even with those signs of improvement, prices are remain higher than before the pandemic. Even if inflation disappeared tomorrow – dropping to 0% for the rest of the year – the inflation rate for December would be 6.5%. That’s unlikely, so the Federal Reserve’s Open Market Committee is expected to keep upping interest rates. Right now, another hike of at least 50 (0.50%) or 75 (0.75%) basis points is set for this week, with more increases continuing into 2023.
The Vanguard analysts wrote that they expect the Federal Reserve to increase its federal funds rate target to a range of 3.25%–3.75% by the end of the year, which will increase rates on mortgages, auto loans, credit cards and other consumer and business borrowing. The aim is to reduce the amount of available money in the economy in order to lower demand for goods and services, resulting in lower prices to bring inflation down.
The higher rates also are designed to increase unemployment, reduce business earnings and frighten business managers and consumers away from spending in favor of conserving cash to avoid running out of money. This is what Federal Reserve Chairman Jerome Powell meant when he recently said that the coming interest rate increased will bring “some pain to households and businesses.”
One indicator the Vanguard projection points to is the spread between the 10-year Treasury bond and the 3-month Treasury bill. In a strong economy, long-term interest rates are higher than short-term rates, such as the 1.64% spread between Treasuries in June, well above the long-term average of 1.20%. Since the end of June, however, the spread dropped to 0.29% by the beginning of September, a strong indicator of potential recession.
How to Prepare Your Portfolio for a Recession
Stocks already are down this year and would decline even more in a recession as corporate earnings suffer. Stocks typically drop before a recession and bottom out before the downturn ends. In the face of a coming recession, investors should:
- If you have a long-term plan that includes riding out downturns, stick to it.
- Consider dividend-paying stocks and other passive income generators
- Build up your cash reserves, including an emergency fund if you face job loss
- To hedge against inflation, look at gold, silver and Treasury Inflation-Protected Securities (TIPS)
- Review your investment plans and asset allocation and avoid volatile stock sectors. If you don’t have one, create one with a trustworthy financial advisor.
The Bottom Line
Vanguard predicts there’s a 65% chance the U.S. will experience a recession in the next 24 months. There are steps, though, investors can take to prepare themselves for a downturn.
Tips for Weathering a Recession
- A financial advisor can help you recession-proof your portfolio, while still growing your money. Finding the right financial advisor is made much easier with SmartAsset’s free tool. In fact, it can match you with up to three financial advisors in your area in five minutes. Get started now.
- Your investing strategy should account for the possibility of a downturn, which is why your asset allocation should be more conservative as you approach retirement. By reducing your exposure to stocks, you can avoid the possibility of your retirement accounts taking a big haircut right as you need them. If you’re still in the market when a recession hits, consider these five things to invest in during a recession.
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