Are we in a recession or not?
For a person simply focused on keeping a job, the distinction between a slowing economy and the beginning of a recession might not matter much. Whether the economy is just weak or in a recession, the risk of losing a job builds. And, of course, the longer and deeper the economic downturn lasts, the greater the risk becomes.
For investors, however, there is a reason for the current preoccupation with identifying a specific time when the economy did, or might, enter a recession. Some market strategists use history as a guide to investing: They time their stock and bond purchases based on where they think the economy happens to be in the economic cycle.
They know that after the damage is done, the market usually rallies nicely. The gloom of awful corporate profits, layoffs and stock losses generally culminates in what Ned Davis Research called a "table-pounding buy" in the stock market.
The problem for investors is identifying where the economy happens to be in the cycle. Economic conditions only become clear in retrospect.
In the 10 recessions since World War II, Ned Davis Research's chief investment strategist Timothy W. Hayes notes, investors anticipated the slowdown before the actual recession and sent the stock-market benchmark Standard & Poor's 500 index down an average of about 8 percent before the recession began.
The market continued to decline for the next five to six months and then began to recover in anticipation of the recession's end.
Hayes found that the low point of every recession since 1945 also turned out to be a bear market bottom, or the worst point in the stock market. Afterward, "the market's performance has been exceptional."
On average, the S&P; 500 has been up an average of 16 percent three months after that low, 24 percent six months later and 32 percent a year later.
Ned Davis analyst Lance Stonecypher has found that health care and consumer staples have been consistent high performers in the six months after the start of recessions, while industrial companies have been the most consistent low performers.
Linda A. Duessel, equity market strategist for Federated Investors, suggests investors protect themselves by buying bonds and large dividend-paying growth stocks.
As bear markets play out, investors must pay attention to short-term rallies that can lead them astray, said Steven C. Leuthold, founder and chief investment officer of the Leuthold Group LLC. For example, he put 5 percent of his portfolio in homebuilders. But after taking advantage of a recent rally, he said, he won't hold onto the group.
Although he lifted his stock market exposure to 50 percent versus 30 percent a month ago, he will cut that back if the S&P; 500 rises to 1,450, a level he doesn't think will hold amid recession and a bear market.
In preparation for continuing weakness in the economy, Leuthold is cutting his exposure to metals such as copper and nickel after investing heavily in them for the last 5 1/2 years. He has about 40 percent of his portfolio in cash.
Besides watching recession trends, investors also should watch for rate cuts by the Fed and central banks throughout the world. The banks try to fight recessions by lowering interest rates.
BCA Research of Montreal has noted that the federal funds rate typically must be reduced at least 60 percent from its pre-recession high before corporate profits and gross-domestic-product growth can reach a bottom.
Applying this rule, the fed funds rate will have to drop to 2 percent, from the current 3 percent, before the rehabilitation process begins, said Chen Zhao, managing editor at BCA Research. Stocks generally start to rally before then, he noted.
But Zhao said that during recent recessions the economy has needed more help than in the past. Rates dropped by 70 percent during the savings-and-loan crisis, a period some analysts compare with the present because it was a period of stress in financial institutions.
As investors look ahead to an improvement in the cycle, Zhao notes that materials, industrials and emerging markets have outperformed global markets for the last six years by huge margins, and that is not likely to continue.
BCA Research cut its allocation to emerging markets to 9 percent from 43 percent last month. Its allocation to stocks in developed countries has increased sharply, to 41 percent from 21 percent last month.
"Monetary conditions are improving at a faster rate in the developed markets than in the emerging-market universe," Zhao said.
gmarksjarvis@tribune.com
Gail MarksJarvis writes for Tribune Media Services. You can leave a message for her at 312-222-4264.