Stocks - February 2009

Economic Fitness Unless you slept under a rock for the last year, you know how awful 2008 was for the economy and the financial markets. With the S&P 500 index logging a 37 percent decline last year, the 2008 market collapse will go down as the third worst year ever for stocks.

Well that was last year. What really matters at this point is what’s ahead. Is the economic patient still in the ICU, or is recovery in the cards?

Judging by the market’s activity over the last several weeks or so, it would seem that the consensus opinion on Wall Street bodes for better days. Since hitting an 11-year low just this past November, the S&P 500 stock index has seemingly stabilized, rallying off of that bottom by nearly 25 percent as of the beginning of this year. Judging by that measure alone, it would seem that prosperity is just around the corner.

But what if Wall Street is wrong? It wouldn’t be the first time. After all, as recently as last spring, Wall Street celebrated the fed-engineered, J.P. Morgan rescue of Bear Stearns & Co. by assuming the financial and economic crisis was over and rallied some 12 percent over a period of six weeks. Except that it wasn’t. And as the economy continued to slide, the rally built on false hopes faltered. Stock prices rolled over and began a sickening five-month slide that pulled prices down by 50 percent. Ouch.

Well, once again, Wall Street has assumed the worst is over. And once again, prices have rallied in anticipation of a near-term economic recovery. But is that near-term outcome likely? And why does Wall Street think there is a near-term economic recovery in the cards anyway? Here’s what passes for analysis nowadays (are you ready for this?): The two longest recessions since World War II (1974 and 1982) each lasted about 16 months. And since this recession started in December 2007, it should bottom around April 2009 or so. But wait, let’s be really smart about this. Since this recession might in fact be a bit worse that ’74 or ’82, let’s add in an additional month or two (because we’re clever) for the recession to end, say maybe May or June. Oh yeah, and since stocks bottom six months or so before the economy does, let’s buy. Simple, huh?

That line of thinking is exactly as it appears — about an inch wide and an inch deep. Yes, for the prior 10 post-war recessions, the above generalizations are correct. But this recession really is different. There are no post-war parallels. Unlike the other post-war recessions, this recession has its roots in the collapse of credit brought on by excessive debt. And history suggests that there are no quick fixes to mop up the aftermath of a credit collapse. It simply takes time for those deflated excesses to be purged from our economy and financial system.

Credit collapses are rare. In fact, there have been only two in modern economic history. The first occurrence of course was the economy of the 1930s. And more recently, Japan experienced an economic credit collapse during the very early 1990s.

You know about the 1930s. Government mismanagement and policy mistakes turned what could have been a fairly normal recession into the Great Depression. In modern Japan, similar policy mistakes have been made. The Japanese economy continues to struggle.

The fed and treasury are currently implementing massive efforts in order to try and rejuvenate our economy. Let’s give them an “A” for effort. They’re really trying not to repeat historic mistakes.

While it remains to be seen how successful they will be, Wall Street is apparently already voting. But know this: as far as the 2009 market outcome is concerned, everything depends on the economy. If this recession ends by mid-year, then yes, as far as the market is concerned the worst may well be over. If, though, by mid-year the economy is still struggling, it is very possible that there could yet again be a significant price adjustment in stocks to reflect that reality. Sort of like last year. We should know soon.

So let me stick out my neck out a bit and offer my two cents on the situation. I have a sneaking suspicion that a year from now, we’ll look back and realize Wall Street’s recent enthusiasm for a near-term recovery was a bit premature.

In 2009, we should aim to survive and prosper — in that order.

Bo Billeaud has been president and chief investment officer of a Lafayette-based money management firm for the past 18 years. Contact him at [email protected]