How to Invest During a Recession
By
Timothy Lutts, Cabot Chief Investment Strategist
For Cabot Wealth Advisory 1/17/08
Sign up for free Cabot Wealth Advisory e-newsletterRecessions, defined technically as two or more successive quarters of negative real economic growth, and officially (by the National Bureau of Economic Research) as "a significant decline in economic activity spread across the economy, lasting more than a few months," are natural, particularly for a mature economy such as ours.
Our current slowdown was initiated by the ending of the housing boom and the resulting evaporation of easy credit. The reverberations from that have affected lenders of all sorts and, in turn, affected most consumers, who suddenly feel they have less to spend.
At the same time, the high price of oil and gas means it's costing us all more to fuel our cars and heat our houses. And we're seeing higher prices for food, too, in part because of the fuel costs involved in food transportation, in part because of the booming, federally subsidized ethanol industry. (China, by contrast, which apparently has no lobbyists from the grain industry, has banned the use of grain for ethanol production, but I'll say no more on that subject; the ethanol issue deserves its own column some day.)
If you want to blame somebody for the current situation you can blame any combination of the following.
A. The Chinese, and their growing appetite for food and fuel
B. The politicians and lobbyists responsible for the ethanol legislation
C. The oil-producing states of the Middle East
D. The environmentalists who've blocked drilling in the Arctic National Wildlife Refuge
E. The automotive manufacturers who continue to sell us gas-guzzlers
F. The "predatory" lenders who misled "innocent" borrowers
G. The lying homebuyers who borrowed more than they could pay back
H. The baby-boomers who drove real estate prices higher and higher over the past four decades in their quest to have it all I. The folks who won World War II and came home and had all those babies!
Well, that last one may be going a bit far. My point is that the situation is multifaceted. There is no one culprit, and there is no one solution.
What makes the current situation even more complex is that if the Fed cuts interest rates at its next meeting on January 30, it risks further inflating the costs of fuel and food! On the other hand, if it doesn't cut rates, the collapse of the housing/mortgage/credit industry is likely to continue until it ends of natural causes...and for folks in all those sectors, it won't be pretty.
Eventually, however, when real estate prices fall low enough, the patient value-oriented souls who've been waiting for bargains will come out of the woodwork and start buying. They'll buy individual houses, apartment buildings, entire condominium projects and more. Downtrends will end. The recession will end. And the U.S. of A. will return to its pattern of slow growth.
But should you wait until then before you invest? No.
One of the most common mistakes made by individual investors is assuming that stocks follow the news, and that by logically analyzing and reacting to the goings-on in the world, they can make money.
The truth, however, is different.
All stocks trade on expectations of the future.
When newbies buy a stock based on a favorable press release and pop a stock up for the day, who's selling to them? The experts, who quietly accumulated their positions in the weeks and months before the announcement.
Similarly, when a stock is trending down for no obvious reason, it's because savvy investors are looking ahead and perceiving (most commonly) that earnings growth in the future will not be as good as expected. That's the situation today.
Knowing this, do you closely follow the economic news to determine when the recession will be over before you invest? Or do you watch the charts to determine when the market downtrend has ended?
Answer: You remember the immortal words of Jesse Livermore, who wrote, "Markets are never wrong; opinions are."
And you watch the charts!
Which is why all the talk about a recession means little to me. I'm watching the charts...which look lousy.
And I'm looking for promising stocks to put on my watch list.
So today, noting what I wrote above about bargain-hunters stepping in, I want to write about finding bargains.
One of my favorite tools for finding bargains is a screen I wrote years ago based on the criteria used by Martin Zweig, who compiled an impressive record of managing money.
Basically, it attempts to find good, high-quality growth stocks that are trading at reasonable prices by asking for the following:
- Positive earnings growth on a year-over-year basis in each of the past four quarters
- Quarterly revenues up over the previous year's quarter
- Current four quarters of earnings exceed trailing four quarters of earnings
- Positive earnings growth over the past two years
- Three-year earnings growth rate exceeding 15%
- Three-year sales growth rate exceeding 15%
- Earnings growth in the latest quarter exceeding the three-year earnings growth rate
- Earnings growth in the latest quarter exceeding 30% or exceeding the rate of the trailing three quarters over the three corresponding quarters from the previous year
- A price earnings ratio of more than five
- A price earnings ratio lower than that of the S&P 500
- Price appreciation that exceeds that of the S&P 500 over the past 26 weeks
- Daily trading volume over a million shares
Whew!
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