Imagine how much more effective investors would be at managing their portfolios if they knew a recession was at hand before the government officially declares a recession. Their long-term profits would almost certainly increase significantly.
With the Vicious Cycle Index (VCI), no imagination is required. Moody's Analytics (MCO +0.36%) chief economist Mark Zandi and his team created the indicator. And it has signaled 100% of U.S. recessions over the last 80 years -- without a single false alarm.
What is this indicator saying now? And what should investors do?
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Why the Vicious Cycle Index is so accurate
Before we answer those questions, it's helpful to understand exactly what the VCI is and why it's so accurate. Zandi and his colleagues based the index on the Sahm Rule, developed by economist Claudia Sahm. The Sahm Rule signals that the economy is in the early stages of a recession when the average unemployment rate over three months rises by 0.5% above its 12-month low.
The approach employed by the Sahm Rule has been highly accurate. It correctly identified nearly every recession since 1950, with only two false alarms. One of those false positives occurred in 1959. Although the U.S. economy didn't enter a recession when the Sahm Rule flashed, a recession began six months later.
The VCI made two improvements to the Sahm Rule, making it more powerful. First, the index adjusts unemployment numbers using a five-year moving average of labor force participation. This helps capture workers who give up on finding a job and leave the workforce. Second, the VCI indicates that the economy is in recession when the average unemployment rate over three months rises by more than 1% over the previous 12 months.
The key to the VCI's greater accuracy compared to the Sahm Rule is that it factors in rising unemployment and lower workforce participation. This change helps it avoid false alarms that can flash when the labor market appears healthy but is actually weakening.
What the indicator is saying about the economy right now
What does the VCI reflect about the U.S. economy now? Zandi believes the index indicates we're already in a recession, even though the National Bureau of Economic Research (NBER) hasn't officially confirmed one yet.
The Sahm Rule isn't indicating a recession, in part because of the seemingly robust 178,000 added jobs in March. However, Moody Analytics' Zandi posted on X (formerly Twitter) that there's more to the story with the March employment gains. He stated that the jobs increase "comes after a big decline in February, when brutal winter and a labor strike at Kaiser Permanente weighed heavily on jobs." Zandi argued that the U.S. has actually added only a few jobs since April 2025 -- and would have a net loss without healthcare employment.
Importantly, the February jobs numbers don't reflect the oil shock created by the war with Iran. The conflict is driving inflation higher. Meanwhile, the labor-force participation rate has fallen to 61.9%, indicating that more Americans are giving up on finding a job. Consumer confidence also hit a record low in April.
Moody's Analytics has raised its probability that the U.S. economy will enter a recession over the next 12 months to 48.6%. That's higher than EY-Parthenon's 40% chance and Goldman Sachs' (GS +0.00%) 30% odds of recession. However, those organizations don't use the VCI.
What should investors do?
Above all, investors shouldn't panic. No economic indicator is infallible -- even one like the VCI that has a perfect track record. However, it's a good idea to be prepared for a recession.
One smart move is to buy recession-proof stocks. Three sectors that tend to hold up well during recessions are consumer staples, healthcare, and utilities.
Walmart (WMT +0.06%) is a good example of a recession-resistant consumer staples stock. AbbVie (ABBV +0.27%) is a major drugmaker whose business shouldn't be significantly impacted by a recession. American States Water (AWR +0.31%) is a leading electric utility that can easily weather an economic decline. All three stocks are Dividend Kings, an elite group of companies that have increased their dividends for at least 50 consecutive years.
On the other hand, investors may want to be cautious about buying cyclical stocks that could pull back sharply if the economy weakens. Small-cap stocks are also often more vulnerable during recessions.
It doesn't hurt to build up a cash position, either. Recessions usually create attractive buying opportunities, so having some cash to deploy could pay off.
What if you ignore the VCI's flashing warning and a recession comes? Hang tight. Recessions typically don't last all that long. Stocks eventually recover. Staying focus on the long term will likely help you make more money than panic selling will.
