Sep 05 Investment Advisor - Recession?

"Do You Feel Lucky?" ~ Dirty Harry.

This past weekend as I was warming up for another Sunday morning pick-up soccer game, I was asked by one of the guys, "So what do you think, John - are we headed into another recession? Should I get out of the market?"

I will not touch that second question here because to do so would be inappropriate, although you can probably guess what my thoughts are on the subject. I do want to address the first question and offer some suggestions as to what that might mean to your hard-earned money if it were invested in the stock market ...

Stall Speed

The U.S. economy is (at best) at stall speed.

GDP growth is anemic (below 2%) and the numbers are trending in the wrong direction. History shows that any time GDP growth dips under 2% for a number of quarters, we are either in a recession or about to start one.

On the other side of the coin, Leading Economic Indicators continues to climb. No recession has ever happened when the LEI has been hitting new highs as it has been for a few years.

You also are probably aware that unemployment is high (above 9%) and isn't showing any signs of coming down. The jobs report from last Friday was just ugly. Other data (real and anecdotal) all indicate that our economy is in trouble.

Does That Mean Recession?

We have conflicting indications from reliable data sources.

One of my favorite economists is Liz Ann Sonders from Schwab. She looks at ALL the data and seems to be a voice of reason while everybody else is letting their emotions get the best of them.

Liz Ann is "Not Throwing in the Towel on Recession" just yet although she, too admits that the odds for a recession are increasing almost every day.

What's Next

The probability of a recession is high and increasing - so your financial choices (both with investment portfolio allocations and daily spending) should keep that in mind. If you play it safe and no recession happens, you might lose out on a little investment upside. But how would you feel if you were fully invested and the market reacted to a recession with average equity losses of about 40%?

If we could keep Europe from imploding (a very big if), Liz Ann Sonders's prediction of a muddle along economy would likely come true. But I just don't see how we can avoid a total meltdown in Europe. If Europe goes, I believe the U.S. economy will drop with it.

This week, Germany's Court Rules on the Legality of the Euro Bank Bailouts. Inspectors Left Greece After Talks were Suspended late last week. Italy must roll over a record amount of debt this month - will people buy it? The entire banking system is tied to questionable debt offerings by countries that make the U.S. Balance Sheet look pristeen.

Investment Responses

So what would happen to your hard earned wealth if Europe imploded and the US economy were to cascade back into a recession?

We have some very cool software that looks at decades of historical data on both economic figures and asset prices. This is the most sophisticated modeling software I have been able to find. According to the statistics, awell designed 60/40 portfolio will lose about 27% from here. U.S. stock market losses will be 40-50% from here and anything invested in Europe or emerging markets (like the BRIC's) will take an even bigger hit.

So it all comes down to that Dirty Harry quote. If you feel like Europe will be able to continue to kick the can down the road and survive for another several months or years ... then your portfolio full of equity positions will be fine and you might even make some money.

Luck is Not a Strategy

Being responsible as an investment advisor for millions of dollars of other people's money puts me in a position where I don't feel all that great about a strategy that relies on being lucky. That is what I think we're looking at with the U.S. economy slowing and Europe unable to find a tractable fix for their sovereign debt problems.

So my answer to my soccer buddy was this, "There is a high and increasing chance that we are either in a recession already or about to fall into one ... invest accordingly."

John