Inflation and higher interest rates could pressure an already-high stock market. Investors can prepare by checking their risk tolerance and deciding how much cash and defensive exposure fit their plans.
On Sept. 28, traders put the odds of an October rate increase at 68%, with about 90 basis points of additional tightening priced in through the end of next year, according to a Reuters market review. Inflation is running hot, and the Federal Reserve is raising rates to fight it. Recession risk is one reason to prepare before markets fall.
A bear market can do more than shrink an account balance. It can show whether a portfolio can withstand losses or whether fear might prompt a sale at the worst moment.
Stocks remain near historical highs, even as geopolitical conflicts continue and companies borrow heavily to build artificial intelligence infrastructure. Those pressures do not guarantee a downturn. But if higher rates push the U.S. economy into recession, a bear market could follow. Planning ahead is easier than making decisions under stress. The Fed raised its benchmark rate by 25 basis points on Sept. 16, to a range of 3.75% to 4.00%. Several officials have since said more increases may be needed if inflation does not cool, Reuters reported.
The U.S. two-year Treasury yield rose 56 basis points in September, its largest monthly increase since February 2023, Reuters reported.
Set your risk limits
Start by asking how you might react to a severe decline. Investors who lived through the Great Recession or the dot-com bubble have seen markets lose half their value. If you have not, picture that kind of loss over 12 to 18 months. It can help you decide whether your current mix of investments feels manageable. Federal Reserve H.15 data for Sept. 29 showed 10-year TIPS yields at 2.63% and 20-year TIPS yields at 2.88%, according to the Fed's H.15 release.
The risk is not just feeling anxious. It is letting anxiety drive a sudden change to a long-term plan. Investors who believe they can stay invested through a sharp decline may not need major changes. Those who are unsure can review their exposure while markets are relatively calm.
Look beyond a headline measure of risk. Check how much of the portfolio sits in higher-risk technology stocks. Consider whether your investment horizon gives you time to recover from losses, and whether you might need to sell stocks to cover near-term expenses. A downturn planning guide also recommends reviewing cash, diversification and borrowing before volatility puts those decisions under pressure.
Build cash without fleeing stocks
Moving everything into cash is not the only way to prepare. Bear markets are part of investing. Every bear market in history has been followed by a bull market that carried stocks to new highs. For many investors, sticking to a considered long-term plan may make more sense than trying to time an exit and reentry.
Some extra cash can still give investors more flexibility. Depending on their broader plan, they might direct new contributions away from stocks for a time or take profits from positions that have risen. Cash can steady a portfolio during a decline. It can also give investors money to put to work when fear-driven selling creates opportunities. If a downturn does not arrive, they simply keep that cash on hand for longer.
Decide in advance what the cash is for and how much fits your goals. Without a plan, a reserve can become a lasting bet against stocks. With one, it may help you avoid selling under pressure and make purchases deliberately.
Make the decision before fear takes hold.
Favor resilience over prediction
Another option is to move part of a portfolio out of higher-risk technology stocks and into businesses that sell essential goods or services. Consumer staples and utilities are often seen as more resilient in recessions because people still need food, beverages and electricity. That history does not shield their shares from market losses.
Coca-Cola has raised its dividend for more than 60 consecutive years. Its dividend yield is reported at 2.4%, and its price-to-earnings ratio is roughly in line with its five-year average. NextEra Energy, a large utility with regulated assets and a substantial contracted solar and wind business, is cited with a 3.2% yield and more than 30 annual dividend increases. The average utility yield is given as 2.8%. These figures describe the examples. They do not guarantee future income or protect investors from losses.
NextEra Energy is pursuing electricity demand with a proposed acquisition of peer Dominion Energy. The transaction is proposed, not completed. Coca-Cola and NextEra show how investors might look for businesses with essential products or services and dividend histories. But sector labels and past dividend increases cannot remove company-specific or market risk. Yield is only one part of an investment's return, and a dividend can change.
Cash and defensive stocks do different jobs. Cash offers liquidity. Shares in businesses that provide essential services can still swing in price. Neither replaces a portfolio that fits an investor's time horizon and ability to bear losses.
Set those limits before volatility arrives. Without them, an investor might abandon even a sensible allocation at the moment it was meant to withstand.
