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 rising to 4.4% in February and core personal consumption expenditures (PCE) still sticky at a 3% pace in December (on an annual basis), the economy remains in a delicate balancing act.
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Economic cycles are natural, but investors can navigate the turbulence by understanding the specific risks ahead.
“Midterm election years tend to be the most volatile of the presidential cycle, with the largest intra-year drawdowns averaging the highest of all four years,” says David McInnis, a wealth advisor and managing partner at Aristia Wealth Management.
Here’s 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 artificial intelligence bubble. While these “aren’t necessarily recession triggers on their own, they could compound into something more serious if they collide,” McInnis says.
The Tariff Effect
The biggest wildcard for 2026 is government policy, specifically around trade tariffs, the national debt and more potential government shutdowns, McInnis says.
Throughout 2025, the administration’s protectionist trade agenda introduced significant volatility. After baseline and country-specific reciprocal tariffs were rolled out, the Supreme Court struck down the Trump administration’s use of the International Emergency Economic Powers Act (IEEPA) for broad tariff actions. This ruling in February triggered a refund claim for companies that paid the tariffs and new legal uncertainty. The administration responded by calling for a 10% global tariff, signaling that the White House intends to maintain a more protectionist posture despite the ruling. This shift has only deepened uncertainty around future trade costs for multinational firms.
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 December strayed further from that target.
In its Jan. 28 update, the Fed acknowledged that inflation remains “somewhat elevated,” but market-based measures anticipate one to two 25-basis-point rate cuts this year. If inflation continues to accelerate 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.
“Cracks beneath the surface, such as rising delinquencies and slowing job growth, could compound the effects on an already stressed consumer,” McInnis says.
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.
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.”
He adds that 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. Recent indicators show cooling momentum, yet not the kind of broad contraction typically seen ahead of recessions.
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 its recent rise shows the labor market isn’t out of the woods yet. Chair Jerome 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, there is “still some tension between the mandates.”
Despite labor weakness, the broader economy shows resilience. The Fed’s January statement noted that the economy has been expanding at a “solid” pace. The Fed did not publish a formal 2026 GDP forecast in its January communication, but private-sector forecasts remain optimistic. For example, Goldman Sachs projects 2.5% GDP growth this year, above the consensus economist estimate of 2.1%.
As of February, a New York Fed model shows an 18.7% chance of a recession by January 2027.
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. He recommends focusing on income-generating investments like government-backed securities and investment-grade corporate debt, alongside global investments, commodities and alternatives.
“I encourage investors to remain invested but focus on diversifying equities and adding some HALO companies,” he says. HALO, or hard assets, low obsolescence, companies have physical assets or products that can’t be replaced by AI. Those include infrastructure and energy stocks.
Some stocks and market sectors are also 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.
Certain individual stocks have also 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.”
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Recession 2026: What to Watch and How to Prepare originally appeared on usnews.com
Update 03/06/26: This story was published at an earlier date and has been updated with new information.
