Waiting For the Second Dip in the “W”

by | Jan 4, 2010 | Cash Flow, Weekly Column

In June of 2009 I wrote a column, “Weathering The ‘W’,” on the possibility we will have a “W” shaped recession and recovery. This model would have the global stock market crash of fall 2008 as the first dip in the “W” and this year’s market rise as the high point in the middle of the letter. The second dip would be another crash, equal to or deeper than the initial one, and the final high point of the “W” would be a sustainable recovery.

I’ve been telling clients that the next potential down leg could actually be years away, rather than months. One factor that that has me really concerned is the looming tax increases slated for 2011. Once those go into effect they will probably put a real damper on any recovery, if not creating an outright economic decline.

Until recently I hadn’t seen this thinking in put in print by any of the financial writers I follow. On December 11, Millennium Wave Investments president John Mauldin blogged an article, “Thoughts on the Statistical Recovery” that is well worth reading.

This is what Mauldin has to say about the “W” recession:

“Finally, this highlights my concern about a double-dip recession. I think we could see one in 2011, as a result of the massive increases in taxes as the Bush tax cuts expire and the Pelosi-Reid-Obama crowd want to raise taxes on the “rich.” Their assumption is that if we could grow quite well in the Clinton years with higher taxes, then we can do it again.

First, if there are no changes to the proposed tax increases, this will be a massive middle-class tax hike. Make no mistake, the Bush tax cuts resulted in a huge cut in the taxes of the middle class. The data clearly shows the wealthiest 20% are paying significantly more of the total taxes paid.

If you combine a large middle-class tax increase with an even larger new wealth tax (75% of which will affect . . . small businesses . . .), it will be a one-two punch to the economic body, when unemployment is already at 10%. You can’t take out well over 2% (and maybe 3%) of GDP from the consumer without it having significant consequences.”

Regardless of whether we will see a prolonged decline, one thing you can count on is a decline of some nature. According to the Leuthold Group, the average rally in the stock market after a bear market low is 55% and lasts 285 days before suffering a market correction of more than 10%. Our current rally has risen about 60% and is approaching 300 days. The second dip in the “W” could begin any time now.

What can you do to prepare for the next down market? The answer is absolutely NOT to get out now and time the market! Those who listened to the conventional wisdom of the experts and got out last March missed the recovery. Most are only now starting to get back into the market, probably just in time to see it decline again.

If you are retired or nearing retirement, however, it would make sense to put one to four years’ worth of income into cash, CD’s, or an ultra short-term bond fund that doesn’t use derivatives.

Otherwise, be sure you have a diversified portfolio with at least five or more asset classes (I use nine). Having cash available for the short term will allow you to leave your portfolio alone to recover, even if the second part of the “W” is slow to come back up.

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