Stock Watch
In Bear-Market Territory
Here's how to invest and adjust your stock portfolios during this slump.
By Andrew Tanzer, Senior Associate Editor, Kiplinger's Personal Finance
January 18, 2008
The bears are on the prowl on Wall Street. After some wild swings, the Dow Jones industrial averaged closed at 12,099 on January 18, down 60 points, or 0.5%. Standard & Poor's 500-stock index dropped 0.6%, to 1325.
The market has already shed a sickening 10% in just three weeks this year and is off 16% from the high set last October 9, meaning that the indexes are close to bear-market territory (generally defined as a drop of 20%). In fact, the small-company Russell 2000 index is already in bear territory, having dropped 20.4% from its peak.
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The stock market is anticipating a recession. You might say that it's come to this conclusion late and abruptly. The bond market, often a more accurate economic indicator, has been signaling recession since yields began declining rapidly last summer.
Certainly the evidence of an economic slowdown is piling up by the day. We're not going to forecast the fact of a recession (defined by some as at least two consecutive quarters of negative economic growth), its duration or severity. But here are some factors to consider as you invest and adjust your stock portfolios during this slump.
If you assume that recession is here or on the way, let's take a look at the dismal history. Tobias Levkovich, strategist at Citibank, calculates that the average stock market decline during all recessions since the 1950s is 26%, or 10 percentage points greater than this market's decline to date.
The average period of index peak to trough during or around a recession is 228 days, with an enormous range of 40 days to more than 400 days. We're about 100 days off the index peak now.
Here's some good news. Since World War II, the frequency and severity of recessions has been declining. For instance, the most recent recession of 2001 was remarkably short and shallow by historical standards.
There are various theories for this trend. One is the triumph of monetarism -- the regulation of economic activity through the control over the supply of and demand for money -- and better monetary policy at the Federal Reserve.
Another is the dramatic improvement in information technology and related advances in logistics and supply-chain management. Recessions in the industrial era were often triggered or prolonged by the build-up of inventories in factories, warehouses and stores. That just doesn't happen any more in today's just-in-time economy.
But here's the bad news. This economic slowdown was triggered by the puncturing of the real estate bubble and the unwinding of financial excesses that were marked by speculation and massive leverage. We're still in the early stages of this great unwinding. Housing prices have more to fall, and the next quarter or two will surely bring a continuing stream of bank write-offs announcements.
Because banks, investment banks and other financial institutions are the lifeblood of an economy, it's hard to imagine a robust recovery or return of a bull market until the banking system is nursed back to health. In fact, an extended period of subdued growth until financials regain their health may be a larger risk than an economic downturn that may or may not meet the technical definition of recession.
Financial stocks will quite likely lead the next bull market. We don't know when that will occur, but in the meantime here are some things to consider when you parse your portfolio.
When you examine the stocks in your portfolio, subject them to a mental stress test. For example, if we do have a recession or a prolonged period of slow growth, will the company survive and, better yet, keep growing?
Ideally, you want companies with bullet-proof balance sheets -- lots of cash and little debt -- and an ability to fund investment through internal sources rather than needing to issue stock or borrow money.
Better yet, can the company continue to pay and increase dividends through a recession? Does it have complete dependence on U.S. consumers, who will need to hunker down and rebuild their own balance sheets during an economic slump?
Strong multinational companies, such as Altria (symbol MO),
Because fear is the great enemy of most investors in volatile times such as these, we thought it might be instructive to ask an emotionless computer for its opinion. So we asked Jeff Mortimer, chief investment officer of Charles Schwab Investment Management, what his purely quantitative bottom-up stock-picking models are telling him. The 19 variables he considers include earnings surprises, free cash generation and momentum.
Mortimer says the computer advises that, even after the sharp retreat in prices of financial stocks, banks such as Citibank (C) are still not attractive.
The industry clusters his computer likes the most are in health care-insurers Cigna (CI) and Aetna (AET), for instance -- and in technology shares, including IBM (IBM). Consumer-staple stocks such as Altria, Coca-Cola (KO) and General Mills (GIS) also stack up well.
Reader Comments (10)
Posted by: Gary at 01/18/2008 08:57:42 PM
I do not understand your advice for a recession, it would seem misguided. During a recession no reason to be in stocks, better to be in cash or in a neutral mutual fund that pays a dividend. Gold etf like GLD and to be more aggresive a short ETF like TWN. That would be a better plan.
Posted by: madmilker at 01/21/2008 09:29:09 AM
Gary....Andrew has a small problem with getting the eggs out of the hen house with a chicken snake in the nest. I think with the age on most of the people in the market today....they ain't lived in a recession nor depression period. They set up them computer type games for what the market "should" do and most couldn't think on their own without a starbucks in one hand and a iphone in the other. If there no common sense put into them ther computer programs ther ain't gonna be no common sense coming out. Five percent return on your money over time will make most all of them little snotty nose "wet behind the ears" people of Wall Street more money than 90% of them ther so call mutual funds that charge people 2% just for the privilege of put'n your money there. One good thing about it....people are gonna find their kitchen again and that's a good thing!
Posted by: Nomen at 01/21/2008 10:10:43 AM
Nothing will get better until the price of gas comes down. When every extra dollar must be spent putting gas in the car to get to work,there often isn't anything left over to pay on the credit card or house payment. The average working person can't afford to run out and buy another more fuel efficient car. That this economic downturn was coming has been obvious to the working class since the price of gas jumped last summer and there was nothing extra left in their wallets. That our wealthy economists can't see these consequences until they show up on a graph six months later only demonstrates just how out of touch they are with the real world.
Posted by: Anonymous at 01/21/2008 02:03:55 PM
To Gary, Spoken like someone who watches a lot of financial commentary. Many times, by the time a recession is declared, it is also over. This is the time to, quite possibly, dollar cost average into high quality stocks during this downturn. Those who do are generally well-rewarded. Those who don't generally miss the significant rally that almost always follows a significant decline.
Posted by: Alex at 01/21/2008 04:12:38 PM
This sounds like what management told Enron employees in convincing them to hold on to their company shares (despite the death spiral). The last person that I'd want to speak to would be a strategist from Citibank!!!! How much did they lose???? The writing is on the wall - get out of stocks (US and Int'l), get out of dollar based investments, know what real inflation is and see the the hype about savings and buy real gold and silver.
Posted by: Vivvie Lee at 01/22/2008 07:12:50 AM
From what I've read the continued unknown risk lies with the large investment banks and brokerage firms in handling SIVs,CDOs and CMOs. These concerns are spreading to the rating firms and insurers of fixed income issues. Call me crazy, but sounds like good blue chip quality stocks and large cap funds are the safest place to be.
Posted by: Tallrussian at 01/22/2008 12:11:12 PM
The article has some good points. A perception and consequences of a recession are different to different people. To some, it may be a disaster. To others, mostly to the younger generation, it's a great opportunity.
I, personally, have made quite a bit of very substantial gains by investing heavily during the 2000-2001 downturn and then waiting for 5-6 years to reap the rewards. You bet I am doing the same again this time as well! In the last 2 weeks, I have adjusted my Roth 401k contributions from 10% to 20%, fully funded my own IRA and my wife's IRA with the full $5000 each for this year, and put $12000 into each of my kids college funds for this year. Of course, my investment horizon is rather long - at least 22 years before my own retirement (that is if I retire at 60), and at least 15 years before my older one starts college. So I see this "recession" or a market downturn, whatever it is, as a great opportunity.
My advice is, keep your long term goals in mind, execute well and follow up on them regularly over the years, and keep at least one year worth of living expenses in cash as the emergency fund so that you would not need to disturb your long-term investments for any kinds of health emergencies, house repairs, etc. With that, one should be able to sail through market swings smoothly and will come out ahead!
Posted by: monkeyfurball at 01/25/2008 12:23:12 AM
Yep, in bear market territory, but if you have the guts to buy many of the good stocks on sale at this time you will make a killing withing 18 months. I put $60,000 into the market today. I love it.
Posted by: Dena Coulson at 01/29/2008 01:46:10 PM
If you have extra money to buy dividend paying stocks where would I start? I am very new at investing and want to invest while the market is down.
Posted by: booboo at 01/29/2008 01:59:02 PM
I have heard that corporate bond funds are the way to go. Also, if you are going to invest $60k because you are excited about buying low, why wouldn't you wait til the market hits rock bottom so that you can maximize your return? I am a recent college graduate, so I am excited about this potential recession so that I can get all of my money in when we are at the trough.