Jay's Homepage with bio and contact info

1. I don't think a recession is coming in the classical sense - a decline in GDP for two or more quarters. I think the subprime morgage market meltdown will slow the growth in the economy but the housing sector was, to a large extent, primed for a fall. A lot of the growth in this sector was risky and where there's a lot of risk involved, bad outcomes periodically occur. (There's a bumper sticker that says this more directly.)

2. The energy market can lead to a downturn in the economy as everyone who was around in the late 70's and early 80's can attest but it's not so much the cost of energy, it's the availability of it. Over the past couple of years, most of our energy sources (oil, gas, electricity) have increased in price much faster than the overall inflation rate. But the economy continued to grow because these energy sources were steady; we didn't have any serious shortages in any of these markets. If that availability continues, the energy sector won't likely be the cause of a recession.

3. Inflation - which is a sustained increase in overall prices - is almost always caused by excessive money growth. The old cliche is right, too much money chasing too few goods. This happens when the monetary authority tries to lower interest rates too much or when a government 'monetizes' their debt (basically prints new money and uses it to finance government spending). The cure for inflation is to stop growing the money supply too much. But that is an imperfect process as well and the cure for inflation is often too little monetary growth and a decline in the economy aka a recession.

4. The vast majority of stocks are sensitive to (positively correlated with) the state of the economy, so most stock prices fall when the economy goes into a recession. Bonds are somewhat less sensitive, but their returns are much lower. The good news is, stock prices rise after the recession ends - usually within two years - so in the long run, a diversified portfolio of stocks will serve an investor well.

There is a caveat to this. If you are about retire, you might not have the time necessary to ride out a market decline. Older investors should shift into safer vehicles (like low risk bonds) even before a recession hits.