Recession? Reaction: Relax

by | Feb 15, 2008 | Cash Flow, Weekly Column | 2 comments

relax.jpgUnless you’ve been on a news fast, you know that the world stock markets have taken quite a dive since December. This was the worst January in history for the NASDAQ (down 9.9%) and the worst since 1990 for the S&P 500 (down 6.3%). I’ve received a number of calls from journalists asking, “In light of the recent market downturn, what’s an investor to do?”

My answer is, “Nothing.” Nothing, that is, assuming you have a well-thought-out asset allocation strategy and rebalance several times a year. Long-time readers of my columns know that a diversified portfolio will include a mixture of world stocks, world bonds, real estate, commodities, market neutral funds, cash, and TIPS bonds.

In a well-diversified portfolio, it’s as normal to have a year with a 15% loss as it is to have a year with a 25% gain. Neither extreme means that anything is abnormal or needs to be changed.recession.jpg

I’ve been telling my clients we are long overdue for a return to a challenging investment climate. The last five years have been exceedingly good. No market stays exceedingly good forever. It appears 2008 may be the “down” year I’ve been expecting for some time. If we are not now in a recession, we will probably be going into a recession sometime this year. It’s not unusual to see stock markets turn downward many months prior to the start of a recession, then rebound months before the recession ends.

How low do I think the market will go? I don’t know, but according to Steve Leuthold, Perception for the Professional, January 2008, 80% of bear markets bottom out close to median valuation levels, which would mean a fall of about 11% from where they closed on December 31st. That would mean around 1300 on the S&P and 11,800 on the Dow. So far, the lows have been 1326 on the S&P and 12,182 on the Dow.

The good news is that most bear markets are much shorter in duration than bull markets, lasting about 18 months. And, lest you think there may be some other market in which to hide, the international markets will probably follow the US.

While we are on the topic of international investments, I’ve received a number of emails from readers concerned about the decline of the dollar, even to the point of moving investments into all non-US related securities. Personally, I think this would be a mistake.

The dollar, which fell to new lows last year against the Euro, will probably continue its slide, in light of the recent interest rate cuts by the Fed. However, I suspect this slide is nearing a bottom. So does Leuthold, who says his research shows the Euro is extremely overvalued and that the dollar would be more fairly valued at around $1.35.

He expects the long-term outlook for the dollar to be bullish against the Euro for these reasons:

• The US economic foundation is stronger than Europe’s.

• In terms of purchasing power, the dollar is significantly undervalued.

• The US is currently on sale.

• The Euro is untested during a significant recession or economic crisis.

• No multi-country common currency has stood the test of time.

speculating.jpgInterestingly, he suggests that the US dollar and the Euro will both weaken against Asian currencies, where economic growth is exploding.

So, while I enjoy speculating as to what the future may hold for world stock and currency markets, I refuse to act on my brilliance—or on anyone else’s. I’ve learned better. Regardless of what I “think” markets will do, I select a well-rounded asset allocation strategy and stay the course. I’ve found it pays great dividends.

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