Inflation or recession: Which should you fear more?

One is here already. The other is lurking right around the corner. Which should worry investors more?

It's a question that's increasingly hard to ignore as the twin troubles of inflation and recession loom over portfolios and pocket books. US prices in June rose the most since 1981. And the odds of a recession in the next year are now close to 50%, according to Bloomberg's monthly survey of economists.

Inflation and recession are closely linked: To battle high prices, the Federal Reserve could raise interest rates so fast that it triggers an economic slowdown. This isn't the case yet, at least not formally, and central bank officials are still saying a so-called soft landing is "very plausible."

Given all this, should you be positioning your portfolio more for continued inflation or an imminent recession?

There is no doubt we're living in an inflationary era. This is why some advisers think it should be top of mind for investors, rather than a hypothetical recession.

"Inflation has a tendency to hit individuals immediately," said Dana Menard, founder and lead financial planner at Twin Cities Wealth Strategies. "It's the 'now,' especially for those that are nearing retirement or need to make a large purchase."

It's important to prepare for recessions too, Menard said. But part of financial planning involves minimizing the agony of fretting over every possible eventuality. Having an emergency fund can allay concerns about an economic downturn and allow you to focus instead on setting a responsible budget and investing in a market that's been battered by inflation.

Investing in this environment is difficult given that we're likely in "the eye of the inflation storm," said Mike Bailey, director of research at FBB Capital Partners. He recommends buying energy and financial companies since they benefit from higher prices. 

It's also a good time to make sure your cash is earning income for you, rather than losing value to inflation. High-yield savings accounts are increasing their rates, while US Series I savings bonds currently offer an annual interest rate of 9.62% if you're willing to lock up your money for at least a year. 

Case for recession planning

While high prices are a pain for consumers — and have put pressure on stocks — some money managers argue that investors should be paying more attention to the warning signals of a recession. 

"Inflation should be largely ignored by investors as it is something that they do not control," said Erik Baskin, founder of Baskin Financial Planning in Ohio. 

What's more, inflation varies significantly from consumer to consumer. The basket of goods used to calculate inflation is based on an average, and not every consumer buys the same items. The data cited each month is also backwards-looking, said Chris Diodato, founder of WELLth Financial Planning in Palm Beach Gardens, Florida. 

"A recession is the biggest concern," he said. "If you get people concerned enough, they're going to stop spending and we've already seen that. They're going to get into hunker-down mode."

Firms do the same thing during recessions, said Katie Nixon, chief investment officer at Northern Trust Wealth Management. From tech to finance, there's already evidence that companies are dialing back on hiring. "It happens in a logical sequence," she said. "First you put on a hiring freeze, then you start to lay off."

Potential job losses are one reason advisers say carefully planning for a recession is so important right now. Having an emergency fund of up to a year could put you in a solid position if you need time to find a new job.

Worst-case scenario: Brace for both

What could be worse than inflation or a recession? Dealing with both at the same time. 

Economists are worried about stagflation, which is characterized by high unemployment and slow economic growth combined with persistently high prices. It happened most notoriously in the 1970s, thanks in part to surging oil prices and a weaker dollar.  

While most experts don't think we're in a period of stagflation now, some are worried it could be coming. Michael Caligiuri, founder and chief executive officer of Caligiuri Financial, is skeptical that the Fed will raise interest rates enough to curb high prices. 

"There's a false notion out there that if we enter a recession, then that'll make inflation go away," he said. "That's not necessarily the case."

Caligiuri recommends investing in hard assets like gold or gold-mining companies, along with other commodities. Despite a recent drop, the Bloomberg Commodity Index is still up about 17% this year, compared with the S&P 500's plunge of nearly 20%. Energy companies are also likely to see more upside, he said. 

"People are still going to continue this rotation out of high-growth, speculative names into the more value-oriented names, especially in the natural resource sector that tend to benefit from high price inflation even during a recession," he said.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement