As Of: July 24, 2001

2001 - Part Two

The Recession Is Still Unfolding. What Now?

   There hasn't been much to say this past month because the stock market has simply been digesting the slow economic environment. I have held the view all year that the slowdown was going to be longer and more pronounced than expected by most people. The effects of inventory liquidation and job cuts are still flowing through the system, and we have not reached the bottom of the economic cycle yet. However, we are starting to approach the bottom of the investment cycle. The stock market anticipates the future economy, and so it should now start looking forward to better times. There are several problems with actually trying to call the bottom of the stock market. 1) Investors have pre-anticipated the bottom so many times already that it is like crying wolf too many times: all credibility has been lost. Most investors won't recognize the bottom when it is staring them in the face. 2) There isn't going to be one clear cut bottom. I expect we will experience a great deal of sector rotation along an extended bottom. By the time the washout is completed in technology, the job cuts will be hurting the consumer, pulling down retail sales, and financial credit quality will be turning down. Housing, which has been holding up while the tech bubble burst, will probably go soft this winter while the wireless communication companies are starting to cycle up with new products based on a newer generation of technology. The government will realize that it needs to spend more on basic infrastructure (roads, bridges, water systems, etc) just as tax revenues start to dry up. Oil prices will come down and energy costs will decrease, which will help chemical companies and transportation companies, but manufacturing will remain weak and discretionary spending for travel will decline. Knowing which sectors to be long and which sectors to short is going to be critical to success for the second half of the year.

   I do not expect to see any kind of a broad, sustainable recovery until we are well into next year. However, the markets always anticipate. I am looking for a stock rally in August followed by a great deal of uncertainty going into the third quarter reporting period. There could be some disappointments that set the market back during the September - October period. Of particular concern will be questions regarding the strength of the holiday shopping period. I wouldn't be betting on the retail sector.

   Once we approach the end of the year, I expect optimism to take over regarding a better economy for next year. Clearly some stocks are cheap now, and others will become very cheap between now and October. But just because stocks are cheap doesn't mean that they will go up anytime soon. Investors trying to bottom fish need to be prepared to be patient.

   One other issue that may finally come home to roost during the second half of the year is the strength of the U.S. dollar. There are indications that the tide is finally turning, and the dollar may start to weaken on the foreign exchange markets. If the dollar were to fall precipitously and cause a confidence crisis, this would have serious consequences for any domestic economic recovery. (Gold may finally move up as a result.)

   As we move into the second half of the year, this is a time of great opportunity and significant danger. It is not a time to sit on ones hands. If you are going to be an investor in the current market, you absolutely must have a disciplined strategy.