Wondering why you may not want to sell stocks, even though risk of recession is rising? Read on.

With summer winding down and market volatility winding up, we are at a point where my current market outlook may seem particularly nuanced. To help clear up any confusion, I’m providing some straightforward answers to the questions I hear most frequently from clients:

  • Are you forecasting a 2020/21 recession? No, although the odds of a U.S. recession in the next year or two are rising. Remember the definition of a recession is at least two consecutive quarters of economic contraction—it may not be that deep or prolonged. My concern is based on global economic slowing, as well as weakness in U.S. industrial and leading economic indicators. The behavior of the Treasury market, where an “inverted yield curve” (when long-term rates fall below short-term rates) is a reliable indicator of recession, also has me on high alert. Meanwhile, trade uncertainty isn’t helping.

  • But isn’t the U.S. economy strong now? Yes. Unemployment is near 50-year lows and wages are growing nicely. Recent retail sales reports have been better than expected. But job growth has been slowing, and corporate earnings are declining. National Income and Product Accounts, a government measure of all corporate earnings (public, private, large and small companies), shows average U.S. corporate profits have fallen 10% since the third quarter of 2018. A contraction in that measure suggests the labor market is likely to weaken.

  • Won’t Fed rate cuts help? I’m not so sure. Markets have already factored in a lot of the expected benefits of future Fed rate cuts. Currently, futures markets have priced in cuts to the short-term federal funds rate over the next six months totaling two-thirds of a percentage point. Also, the yields of 10-year and 30-year Treasuries, which reflect key borrowing rates for businesses and consumers, are already very low. It may be that the Fed is the wrong medicine for what ails.

  • Should I sell my stocks? No. I expect volatility to remain elevated and think that we may see a 5%-10% correction in stock prices in the next few months. Since the expected market dislocation is modest, I don’t think abandoning stocks is the right move and don’t suggest trying to time the market. Instead, stay allocated to stocks, but shift toward actively managed, value-style funds that seek stocks with high quality cash flows and dividends. With those income sources, you effectively get paid to stay invested in equities and wait for the economic smoke to clear. 

We’re nearing the end of the business cycle, which can be particularly tough to navigate, as investors often attempt to anticipate the future, at the same time that policymakers are trying to have an impact on the economic outlook.

Market volatility has already increased this month and I expect it will pick up more in the next few months. My advice is to try to remain patient and avoid reacting with emotion.