Chances are your stockbroker or financial planner is telling you to buy stocks now. Oh, there is a chance they will go down in the short run, he or she will say, but in a fairly short time you will realize that late fall of 2008 was the time to buy stocks because they were so cheap. “Buy when the blood is running in the streets” is the relevant Wall Street adage.
But there is another Street axiom: “Don’t try to catch a falling knife.” While it’s true that many stocks are very attractive if the recession is moderate, and any rally could go on, there are three good reasons to ponder before putting your toe in the water: (1) This may be a secular (as opposed to cyclical) bear market. (2) A deep recession may grind all through next year and even into 2010. (3) The world’s governments and central banks are now throwing trillions of dollars at the credit crisis to fight deflation, or falling prices. But once they are successful, all that money and credit will cause the opposite: nagging inflation. That could be three years from now, but stocks and bonds will move in advance of the data.
Let’s take them one at a time. We are all used to cyclical bull and bear markets that last about a year. However, a secular bull or bear market is one that hangs on 15 to 17 years or more. For example, 1983 to 1999 represented a secular bull market. Stocks rose an average of more than 15 percent a year. Whoopee! From 1950 to 1965, they rose 10.6 percent a year. But look at the gloomy side. Those who bought stocks at the peak in 1929 didn’t get their money back until the early 1950s. From 1966 to 1982, stocks rose about 1.6 percent a year, but inflation was horrendous then, often running more than 10 percent. Stock buyers lost massively in that secular bear.
Now, this doesn’t mean that you can’t make money in a secular bear market. There are cyclical bull markets that take place inside the secular bear — periods of a year or so when the market trends upward. Also, even if you are in a cyclical bear inside of a secular bear — theoretically the worst of all worlds — you can make good money on certain stocks if you choose correctly.
The consensus of economists is now that the U.S. economy will contract in the fourth quarter of this year and the first and perhaps second of next year. But there are some who say this downturn could last well into 2010. Be forewarned: the economists who are most pessimistic now made the accurate predictions months ago, when the optimists thought there might be no recession.
World governments and central banks have taken unprecedented moves to get banks to make loans again. Wielding the prod, governments now own big chunks of the biggest banks. The rationale is that inflation is bad, but deflation is awful, as the world learned in the 1930s. But the gobs of money and credit used to whip deflation may cause inflation three years from now.
E. James Welsh of Carlsbad’s Welsh Money Management believes that we’re in a secular bear that will last to 2016 or 2017. It may have begun with the shorter bear market of 2000–2002 or the current one that began midyear 2007. For months, he has been telling his clients to sell their stocks and go into cash equivalents. “You may be making 1 or 2 percent in a money market fund, but if assets are going down 30 to 40 percent in value, your purchasing power is going up,” says Welsh. He thinks the Dow Jones Industrial Average, now above 9000, could go as low as 6000 or 7000. “It may not happen until next year sometime. Most of the guys will say the market is cheap, there will be a recovery in mid-2009. If we see some stabilization in the credit markets, the bulls will come out and cause selling pressure to dry up. But the idea of a recovery in the second half of 2009 is too optimistic,” and reality will drive the market back down.
Welsh also suspects that in three years, after all the money has been thrown at fighting deflation, inflation will raise its ugly head again. “Government deficits will be gigantic. We’re in one hell of a pickle.”
Robert Snigaroff of Denali Advisors concluded that we were in a secular bear in September of 2000 and has had well over half his portfolio in cash equivalents since then. Stocks may stage rallies in the short run, “but they are not that good a bargain now and are not likely to do well in the long run,” he says. Greatly because of the trillions of dollars of dangerous derivatives poisoning the financial system, “We are in a slow-motion crash.”
Neil Hokanson of Solana Beach’s Hokanson Associates thinks there is a “good chance” that this is a cyclical bear, but he, too, doesn’t know if it started in 2000 or 2007. Analysts often wonder whether an economic or market recovery will be V-shaped (bouncing right back), U-shaped (bouncing back after a pause along the bottom), or L-shaped (plunging and then running flat along the bottom for a long time). “What will surprise people is that the recovery may not be sustained. People will think we are off to the races, but it will be kind of an L-shaped recovery, a longer slog” for both the economy and stocks, he says. He believes inflation may return: “Government is borrowing from the future. At some time that has to be inflationary.” But this could cause bond yields to rise, making stocks more competitive against bonds.
In this slog period, there will be winning stocks. Certain consumer stocks are generally stable, such as Johnson & Johnson and Teva Pharmaceutical, the Israeli maker of generic drugs. Femsa, a Mexican seller of both soft drinks and beer, fits in perfectly with the young population there, says Hokanson.
John Messner of Messner and Smith suspects we’re in a secular bear market. “Hedge funds and mutual funds are liquidating stocks” as their investors pull their money out, and the process may last a long time as the world deleverages, or sheds excessive debt. “I pity the new president,” he says; there is so much that has to be done to pump the economy up and then to try to stave off inflation after the job is done. “We definitely have toasted the consumer,” says Messner. That’s one reason he likes stocks like Jacobs Engineering, which has been cut in half. Among many things, it does scientific and environmental engineering and consulting for governments all over the world.
Mike Stolper of Stolper and Company, which advises wealthy families and foundations, says this is no secular bear. “It fits the contours of a cyclical bear market,” says Stolper. “In terms of intensity, we saw a full-blown financial panic.”
The bad news has been compressed into a short time period. “This is a head fake,” says Stolper. “We will have a short, sharp recession,” says Stolper. There will be a V-shaped recovery in both the economy and stocks. “A year from now, we will have difficulty remembering whether the swoon took place before or after the election.” In particular, he notes that stocks were reasonably valued in relation to their earnings and book value before the sell-off commenced. At the market’s bottom, those valuations will be extremely compelling. But people hold off buying: “They look to the [stock] market as a gauge of prosperity, and they have this vague feeling they are being bankrupted.” But the fear will evaporate quickly, Stolper predicts.
“I don’t know that it is a secular bear,” says hedge fund pro Todd Buchholz, Solana Beach author/economist with degrees from Cambridge and Harvard Law. “The economic problems are more than can be patched over. So much restructuring is needed.” For now, hedge funds and mutual funds will be selling heavily because of redemptions, and there won’t be enough buying power on the sidelines. “If the credit markets unlock, we will be out of this in the spring. The consensus is that we will stay down a long time. I don’t agree.” He thinks the stock market will be higher a year from now.