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THE MARKETS GOING FORWARD
“The definition of an economist is a person who has correctly predicted two of the last seven recessions”
By Richard L. Kesner, President
The CommonWealth Group
February 2008
One of the best books of last year was Blank Taleb’s “The Black Swan.” Taleb is very controversial, but also is very accurate in his opinion of forecasters and prognosticators. He describes them as follows:
“Some professionals have no differential abilities from the rest of the population, but for some reason, and against their empirical records, are believed to e experts: clinical psychologists, academic economists, risk “experts,” military analysts, CEOs, et cetera. They dress up their expertise in beautiful language, jargon mathematics, and often wear expensive suits.
We may or may not have a recession this year or next year. The fact is that no one knows what is going to happen tomorrow, next week, next month, next year etc. We have all lived through and experienced recessions in the past and this too will pass (if we actually go into a recession.) What is a recession and how it affects us all are really the most important questions.
Wikipedia defines a recession as follows:
“In macroeconomics, a recession is a decline in any country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. However, in the United States the official designation of recessions is done by the business-cycle dating committee of the National Bureau of Economic Research (Feldstein, 2007). The American National Bureau of Economic Research defines a recession more ambiguously as "a significant decline in economic activity spread across the economy, lasting more than a few months." A recession may involve simultaneous declines in coincident measures of overall economic activity such as employment, investment, and corporate profits. Recessions may be associated with falling prices (deflation), or, alternatively, sharply rising prices (inflation) in a process known as stagflation. A severe or long recession is referred to as an economic depression. A devastating breakdown of an economy is called economic collapse. Newspaper columnist Sidney J. Harris amusingly distinguished terms this way: "a recession is when you lose your job; a depression is when I lose mine."
The dictionary defines a recession as follows:
“A recession is defined to be a period of two quarters of negative GDP growth.”
“Thus: a recession is a national or world event, by definition. And statistical aberrations or one-time events can almost never create a recession; e.g. if there were to be movement of economic activity (measured or real) around Jan 1, 2000, it could create the appearance of only one quarter of negative growth. For a recession to occur the real economy must decline.”
OK, so we seem to have a declining economy. I think this has happened in the past a few times. I also believe that after a recession comes growth, and that the growth is usually strong growth for a number of years. So to put it in perspective, we would have some slightly negative news for six or maybe nine months and then a number of YEARS of sustained growth.
Investors are asking me what our strategy will be for portfolios if and when we have a recession. My answer is nothing different. That is because we are not concerned with short term fluctuations of your portfolios either positively or negatively. We are concerned with meeting your long-term goals and objectives. Our portfolios are structured to minimize volatility according to your guidelines.
INTEREST RATES AND INFLATION
We continue to tell you that the long-term problem with your investments is not principal protection but inflation protection. Long-term Treasury Bonds are currently yielding 3.9% interest. This is a negative return for those investors who believe that the government inflation rate of 3% is accurate, and even worse if you believe like we do that inflation is currently running between 6% and 7% per year.
I am talking about taxable investments so when we receive 3.9% on our treasury investment and we assume a 35% bracket we have a net return of 2.54%. Subtracting the 3% inflation (purchasing power) from the 2.54% net returns we have a real return (return net of inflation) of -0.465%.
There was an article in the Sunday, January 6, 2008 Business section of the Sun Sentinel about the rising cost of food prices. Remember that both energy and food are excluded from the government’s inflation calculations. Here is the bad news:
“National average price increase of some foods from November 2006 to November 2007”
Whole Chicken per pound: +11%
Ground chuck per pound: +6%
Eggs per dozen: +38%
White bread per pound: +7%
Milk per gallon: +30%
Now, add some energy increases into the equation and you can see why we need to compound money at 6% - 7% to stay even. Statistics show that a person age 62 has a high probability of living 30 more years. In order to stay even with inflation your nest egg (investments) must earn 6% to 7% per year net of everything, and the only vehicle that has a chance of doing that is equity investments. Not gold, not oil, not real estate, just plain good old stocks. Yes, they go down, but overall they go up and when you have a recession you have a buying opportunity that could provide you fabulous returns going forward. Let’s understand this now. Recessions are good for equity investors because they allow us to invest in the best companies in the world when they are on sale.
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