As Of: March 13, 2001
Question: Will we have a recession?
Answer: Does a duck have lips? The semantics are not important. If your neighbor loses his job, it is a recession. If you lose your job, it is a depression. Hundreds of thousands of job cuts have recently been announced and more are coming. Will we meet the technical requirement of two down quarters (lack of economic growth)? Yes, but that is not really important. The individual is really only interested in two things: how to handle his personal budget, and how to manage his investments. (As for your personal budget, it should have been obvious for years now that interest rates were coming down. This means that wise people should have reduced their debt and expenses. This does not appear to be what most people have actually done. One can conclude that debt liquidation will become a significant issue.)
Question: Won't a recession affect the investment markets?
Answer: The markets predicted a recession in December, and then canceled the recession in January before it even became of record. The belief that the Federal Reserve could protect the economy from a downturn was a fallacy. Now a recession is underway. You cannot have trillions of dollars of value sucked out of the stock markets without causing a ripple effect. Studies show that the wealth effect is tenuous when the markets are going up, but the effect of wealth destruction has an immediate psychological impact when markets go down. Investment value is driven by earning power. Obviously earning power decreases when the economy slows down. The dramatic drop in stock prices has been the result of a drop in earnings projections.
Question: Have the markets put in a bottom?
Answer: Wrong question. First, there is never exactly one bottom. Different stocks and different sectors bottom at different stages. Second, picking the exact bottom is an unnecessary exercise in futility. When investments of interest get close to a bottom, start averaging in; and when they get close to a top, start averaging out. It should not be an all-or-none decision, and it is not really an in or out decision. It is an asset class decision based on the recognition that one area of investment is going to start to outperform another area, and assets should start to be shifted.
Question: So where are we?
Answer: The Nasdaq is getting washed out. There are some very cheap stocks, but not all stocks are cheap. Also, some stocks may be cheap, but the companies may not survive. It is important to analyze each stock based on the strength of its balance sheet, its earnings growth potential, and its relative value. It is also important to recognize that we are still early in the down cycle. I think it is unrealistic to believe that stocks such as the home builders (which are still near their highs) won't come down as the impact of the slow down ripples through the economy. It is also unrealistic to think that financial organizations won't be affected by credit quality issues. The question of adequate loan loss reserves will surface in the next few months. What this means is that stocks that are a good value now, may not have much of a catalyst to go up until the rest of the economy bottoms. This also implies that some "old economy" stocks which may be thought of as a safe haven are also subject to a further drop. Both the Dow Jones Index and the S&P 500 could go lower to come more in line with the Nasdaq.
Question: Are you saying it is too early to bottom fish?
Answer: No. I am saying you can start to dollar cost average in, but your expectations should be multi-year. It will probably take twelve months to work through this recession, and two or three years to feel like we are making real progress in investment growth. This is not to imply that we will ever see Priceline.com go back over $100 or see Yahoo go back over $200. But it is not unreasonable to expect that some of the really cheap quality stocks can be up 30% to 50% in two years and double in four years. However, expectations should be much lower than they were in the late 1990's.
Question: Is it too late to buy bonds?
Answer: The trick is to be positioned ahead of the crowd. If you are selling stocks now to buy bonds, you blew it. If you had listened to me over the past two years, you would be holding bonds (including foreign bonds), REITs, utilities, energy, and gold. I would continue to hold on to bonds in anticipation of lower interest rates. I would continue to hold on to foreign investments in anticipation of a lower dollar. But I would be thinking about, if not actually beginning to, position back into stocks that are finally returning to realistic values. Remember, the Wall Street analysts didn't tell you to sell when the markets were at their highs. They aren't likely to tell you to buy until it is obvious to everyone. By then you may have missed the sweet spot to own some of these cheap stocks. But do not be too eager either. Buying stocks into a recession should be a gradual process that involves a lot of patience.
Question: Any final advice?
Answer: We are in a period of gradual asset reallocation. As adjustments are made between various asset categories, the result should still continue to be diversification. The best protection that you can have in volatile and uncertain markets is to be diversified.