The U.S. economy managed to navigate a volatile 2025 without collapsing, but the cumulative effects of ongoing trade tensions and persistent inflation keep concerns about a 2026 recession on some investors’ minds.
The Federal Open Market Committee decided to hold interest rates steady at its January policy meeting after three consecutive 25-basis-point cuts in late 2025 that put the target range at 3.5% to 3.75%. Meanwhile, the Donald Trump administration’s trade policies continue to create headwinds, but the Federal Reserve’s latest projections paint a resilient picture. The Fed’s upgraded 2026 GDP growth forecast is 2.3%, up from a previous estimate of 1.8%. However, with the unemployment rate at 4.4% and core personal consumption expenditures (PCE) still sticky at 2.8% for November, the economy remains in a delicate balancing act.
[Sign up for stock news with our Invested newsletter.]
Economic cycles are natural, but investors can navigate the turbulence by understanding the specific risks ahead. Here is an analysis of the likelihood of a recession in 2026 and how to position portfolios accordingly:
— 2026 recession risk factors.
— Will there be a recession in 2026?
— What to invest in during a recession.
2026 Recession Risk Factors
While the Fed is projecting growth, four key threats could derail the economy in 2026: policy-driven inflation, “stagflation lite,” consumer exhaustion and a potential AI bubble.
The Tariff Effect
The biggest wildcard for 2026 is government policy, specifically around trade tariffs, the national debt and more potential government shutdowns, according to David McInnis, a wealth advisor and managing partner at Aristia Wealth Management.
Throughout 2025, the administration’s protectionist trade agenda introduced significant volatility. Following baseline tariffs implemented earlier in the year, higher reciprocal rates were levied on select trading partners in August. Though they have since moderated, this shift away from a highly interconnected, globalized system created uncertainty for multinational businesses.
While supporters argue this stimulates domestic manufacturing, the immediate effect has been uncertainty. There is a risk that bringing production back to the U.S. will raise production costs and reduce supply chain efficiency. If these costs are fully passed on to consumers in 2026, the Fed is more likely to continue to halt rate cuts, potentially choking off growth. On Jan. 30, Trump officially nominated Kevin Warsh to lead the central bank when Powell’s term expires in May 2026, which adds another layer of uncertainty for some investors.
The “Stagflation Lite” Scenario
Some have warned of a “stagflation lite” environment, where growth is sluggish but inflation refuses to fall back to the Fed’s preferred 2% target. In fact, core and headline PCE in November strayed further from that target.
In its Dec. 10 update, the Fed acknowledged that inflation remains somewhat “elevated,” projecting 2.4% PCE inflation for all of 2026. If inflation re-accelerates due to tariffs while the job market continues to cool, the Fed could face a scenario where it’s unable to cut rates to save jobs without fueling price hikes. The latter would put “major pressure on consumer spending, especially for the middle- to lower-income consumer,” McInnis says.
Consumer Exhaustion
The U.S. consumer has been the indomitable engine of the post-pandemic economy, but that engine is showing signs of sputtering out. High interest rates throughout 2024 and 2025 have taken a toll on household balance sheets.
“Rising credit card delinquencies, car loans and a depletion of pandemic-era savings could finally cause the U.S. consumer to inflect into a psychology of savings and austerity,” McInnis says.
While headline spending has remained positive, McInnis warns of “cracks beneath the surface, such as rising delinquencies and slowing job growth, which could compound the effects on an already stressed consumer.”
David Schneider, a certified financial planner and president of Schneider Wealth Strategies, echoes this concern, noting that the economy in 2026 faces a threat from “a consumer breaking point where households, exhausted by high inflation and record debt, finally hit a financial wall.”
The Potential AI Bubble
The massive run-up in technology valuations, driven by the artificial intelligence boom of the mid-2020s, presents a unique structural risk. If the astronomical capital expenditures by major tech firms do not yield profitable returns soon, the market could face a severe correction.
“There is a fear that the massive investment in AI could lead to an asset bubble,” McInnis says. “If this bubble bursts or if AI productivity gains fail to materialize quickly, it could cause a derisking and reassessment of AI valuations.”
A collapse in these valuations wouldn’t just hurt stock portfolios; it could trigger a “reverse wealth effect,” according to Schneider. In this scenario, “a bursting AI bubble could evaporate the paper wealth that is currently propping up high-end consumption.” While Schneider admits “it is impossible to know whether these risks will materialize,” the impact on market sentiment would be immediate.
[Read: 7 Best Data Center Stocks, ETFs and REITs to Buy]
Will There Be a Recession in 2026?
Whether you consider a recession likely in 2026 depends on the narrative you believe, according to Schneider.
“The odds of a recession in 2026 represent a battle between warning signals coming from the labor market and consumer sentiment versus a consensus that believes corporate investment and an accommodative Fed will save the day,” he says. “The economy is literally moving at two speeds, with businesses and affluent households stimulating growth, fueled by AI spending and record asset prices, while the average person is increasingly anxious and financially exhausted.” The outcome for next year will depend on if “top-heavy spending can continue to overcome broader economic vulnerabilities.”
The data suggests a slowdown is likely, but a full-blown recession is not necessarily on the horizon for the U.S.
The primary driver for the Fed’s recent rate cuts was the softening labor market. The unemployment rate, at 4.4%, is historically low, but the labor market isn’t out of the woods yet. Powell stated after the Fed’s January policy meeting that “the upside risks to inflation and the downside risks to employment have diminished.” However, he acknowledged, “We still have some tension between employment and inflation, but it’s less than it was.”
However, says McInnis, “Cracks beneath the surface, such as rising delinquencies and slowing job growth, could compound the effects on an already stressed consumer.”
Despite labor weakness, the broader economy shows resilience. The Fed’s revised forecast of 2.3% growth for 2026 suggests that officials see the economy expanding at a healthy pace. As of Jan. 22, the New York Fed model showed a 20.4% chance of a recession by December 2026.
McInnis believes a more likely scenario is a potential market melt-up. This occurs when stock prices accelerate rapidly, often above what fundamental analysis suggests they’re worth. “If the market were to move 25% or more over the next year, this could indicate an unsustainable melt-up type of situation,” he says. However, he’s not suggesting this will occur in 2026.
What to Invest In During a Recession
Predicting the direction of the economy is nearly impossible since there are always conflicting signals, Schneider says. “Smart investors accept the limits of prediction rather than betting on a single, uncertain outcome.” As such, the best strategy is one of preparedness, not prediction.
“You should adjust your cash reserves to be sure you have adequate liquidity to weather an economic storm, but you shouldn’t drastically alter your long-term investment strategy based on economic forecasts,” he says. Cash may not be the most exciting play, but it reduces market risk and provides financial flexibility if a recession creates potential buying opportunities in 2026.
You might use this opportunity to rebalance your portfolio, trimming high growth areas to buy more attractive valuations, McInnis says. Some stocks and market sectors are more defensive than others and tend to outperform the rest of the market during recessions. Utility stocks, health care stocks and consumer staples stocks are considered defensive investments because their earnings tend to be insulated from economic cycles and swings in consumer confidence.
In addition, certain individual stocks have outperformed during each of the past two U.S. recessions. Walmart Inc. (ticker: WMT), Netflix Inc. (NFLX) and T-Mobile US Inc. (TMUS) are just three examples of stocks that beat the S&P 500 in both 2008 and 2020.
That said, investors with longer-term financial goals have another alternative as well — simply ignore a recession and stay the course.
Since 1948, the S&P 500 has declined an average of 2.4% during the six months prior to a U.S. recession. However, it has gained an average of 3.5% during those recessions and has averaged a 20% gain in the 12 months following the end of a recession.
“The stock market usually drops months before a recession starts and begins its recovery well before a recession ends,” Schneider says. “The worst move is often sitting on the sidelines, as the biggest market gains typically occur while the economic news is still terrible.”
More from U.S. News
9 Best Growth Stocks for the Next 10 Years
5 Best Gold ETFs to Buy for 2026
Recession 2026: What to Watch and How to Prepare originally appeared on usnews.com
Update 01/30/26: This story was previously published at an earlier date and has been updated with new information.
