How to Invest during a Recession

 
Last Saturday night I had the pleasure of watching the Patriots-Jaguars playoff game on a friend's 100-inch high-definition projection screen. Did any of us wish we were actually attending the game in chilly Gillette Stadium in Foxborough, Massachusetts? No. With a screen like that, we felt as if we were right on the field!

Plus, we got to sit in comfy chairs and eat delicious homemade pizza before the game ... which is when a female friend who works in the government/tourism sector asked me, "Do you think we'll have a recession?"

Good question, bad timing. Because I have a simple answer and a complex answer to that question. And the simple answer, which is appropriate at such a party, sounds flip.

It's "Yes, we'll have a recession, but I don't care." Or, a little less coldly, "Yes, we'll have a recession, but it doesn't really matter to me."

So now here's the complex answer, for Annie and everyone else, too.

Complex Answer to Recession Question

Recessions, 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, as I explain in the next section.

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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.

Finding a Bargain

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!

Back on September 10 when I last wrote about stocks selected by the Zweig screen, the stock I recommended was Amedisys (AMED).

I wrote, "The company provides home nursing services through 261 nursing offices and 14 hospice offices, in 19 states. To me, this is a very attractive business in the long run; just as baby-boomers drove the housing market up, I think they'll drive the health care market up, too."

"Amedisys ... manages diabetes, provides wound care, geriatric surgical recovery, occupational therapy, speech therapy, and social therapy. It provides terminal hospice care and therapy staffing services. ... Medicare accounts for 93% of revenues today, while the remainder is paid by Medicaid, private payers and private insurance companies."

"Going forward, I think the government will continue to pay an increased part of this load, because baby boomers will demand it. And companies like Amedisys will be the big winners."

Back then, Amedisys was trading at 38, sitting right at its 50-day moving average. Today, while the broad market is on the skids, the stock is at 48, just off its high of 50. That's a gain of 26% in just four months ... not too shabby. I'm not recommending it here; I think the stock needs time to digest this gain. But the stock does still pass the Zweig screen, so on a decent pullback it would be attractive.

The stock I want to highlight today, in the hope that it can do as well as Amedisys did over the past four months, is Oracle (ORCL).

Oracle, of course, is well known. It's one of the giants of the computer software business, with $20 billion in revenues and a nearly perfect record of annual earnings growth over the past decade. In the third quarter, it saw revenues grow 28% while earnings grew 41%. And after-tax profit margins are a fat 30.4%

This year, the company's earnings are expected to grow 26% to $1.27 per share, yet the stock is trading at just 17 times those estimated earnings. And that's cheap.

I look at the chart, and I see a stock that's been in an uptrend since the market bottom in 2002, but it's an uptrend that's still not hot. As I write, the stock is at 22, which is just where it was in late September. The 50-day moving average is at 21.

Finally, I also note that Oracle is recommended in Cabot Benjamin Graham Value Letter. By editor Roy Ward's calculations, the stock earns a score of 9.29 on a scale of 10, scoring especially high on the scales of both growth and technical rating and somewhat lower on the scales of value and quality.

If you had to buy one stock today, my guess is you won't do badly with Oracle, regardless of what the market throws at you.

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Editor's Note

Oracle may never be mentioned here again, but if you'd like continuing coverage of the stock, as well as guidance on buying other undervalued stocks, you can find it in Cabot Benjamin Graham Value Letter. Using the classic value investing system developed by Benjamin Graham and since modified by buy-and-hold master Warren Buffett, it's your guide to low-risk, low-turnover investing, and thus ideal if you're tired of reacting to the market's gyrations ... or if you simply want to take off on a cruise! To get started with a no-risk trial subscription, simply click the link below.

http://www.cabotinvestors.com/ebgvicwa12.html

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher
Cabot Wealth Advisory

Timothy Lutts can be found on Google Plus.

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