Is the sky falling?
Judging from the response to last week's column, many of you believe that it is. The media is fueling this pessimistic frenzy, with endless stories about the coming "recession/depression" and the sad state of the economy.
I deal with this issue in this week's column.
Thank you for all your comments. Please continue to add your questions as comments and I will do my best to answer them.
Question From cylindar:
The recession is already here. Anybody with half a brain can see that No one needs analysts to see this very clear and lucid fact. Now my question to you is why are you so scared of calling a spade a spade. Or are you really that confused about what a recession is all about. Either way I do not think I would go to you for financial advice. You do not seem to know whats going on right in front of your nose.
Question From rintincop:
A recession means anybody long stocks is gonna get hit hard. The buy and hold strategy being promoted in the article is bad advice.
Question From SubparDude:
Smartest advice: DUCK!
Better advice: RUN!
Clylindar, Rintincop, SubparDude, and WIpatriot,
I am taking all of your questions and views together because they are representative of the feelings of many investors.
The markets are dropping like a stone. The concern of investors is certainly understandable.
It seems like we must be in a recession or at least headed for one. The financial media bombards us with a daily barrage of negative news.
What's going on and how should investors react?
Is Cylindar right? Can anyone with "half a brain" see that we are already in a recession?
A dispassionate view of the data indicates that the answer to these questions is "no" and "no."
No reputable economist holds the view that we are already in a recession. In fact, the majority of economists believe that we will not go into a recession in 2008.
Economists at the University of Michigan, who base their forecasts on the Michigan Quarterly Econometric Model of the U.S. economy, issued a report in which they forecast no recession in 2008.
The International Institute of Finance agrees. This is a highly respected organization of more than 300 commercial and investment banks, insurance firms, and multinational corporations, located in 65 countries. It sees slower growth but no recession.
And what about the Federal Reserve Board? Contrary to the views of many, it does not make predictions about the likelihood of a recession in a casual manner. Its approach to this task is summarized in a recent study entitled Financial Market Perceptions of Recession Risk, which discusses the 54 variables it considers.
The Financial Reserve Board believes a recession is not likely in 2008.
Knight Kiplinger, the editor-in-chief of Kiplinger's Personal Finance Magazine, and one of the nations top economists, believes we will avoid a recession in 2008.
The highly respected U.C.L.A Anderson Economic Forecast does not believe that a "national recession is on the economic horizon." Edward Leamer, director and co-author of the forecast predicts a rebound in the economy starting in the second half of 2008.
A panel of ten leading economists polled by MSNBC concluded that the economy will avoid a recession in 2008.
Only two of 54 economists polled by Business Week predict a recession in 2008.
A survey of economists polled by Bloomberg found that the odds of a recession in 2008 was only 40%.
Diana Furchtgott-Roth, a senior fellow at the Hudson Institute and the former Chief economist at the U.S. Department of Labor, has stated that that "on balance, it is not likely that the United States will experience a recession in 2008."
According to its web site, the Hudson Institute presents "... well-timed recommendations to leaders in government and business, domestically as well as abroad."
T.D. Waterhouse predicts no recession in 2008 and that the markets will rise in 2008.
Clearly, there is an active debate among highly trained, well respected economists over the issue of whether we will have a recession in 2008. Investors who are assuming that a recession is a foregone conclusion and who counsel others to panic or "run", are ignoring this undeniable fact.
The role of the media in fueling this one-sided, pessimistic view of the economy is particularly troubling.
In a recent study entitled "Giving Content to Investor Sentiment: The Role of Media in the Stock Market," Paul C. Tetlock studied the effect of negative financial news on the markets. He concluded that "high media pessimism predicts downward pressure on market prices followed by a reversion to fundamentals..." The study finds that the adverse price impact of media pessimism is particularly acute with small stocks.
Translation: It may not be solely the fundamentals that is depressing stock prices. To the contrary, the study notes that "...the hypothesis that pessimism represents negative fundamental information not yet incorporated into prices receives very little support from the data."
Why does the media hype negative news?
Because bad news sells papers and increases ratings.
With all of this uncertainty, what should investors do?
A recession will place continued downward pressure on the markets. The worst period in the last 50 years for the markets was 2000-2002. The S&P 500 was down an aggregate of 37%.
However, investors who held a globally diversified portfolio of 60% stocks and 40% bonds, in low cost index or passively managed funds, broke even during that period.
Whether or not you believe there will be a recession, you should always be focused on your asset allocation, which should be appropriate for your investment objectives and tolerance for risk. If the prospect of continued volatility in the markets is too much for you to handle, you have the wrong asset allocation.
The only good news about all of this doomsday talk is that it might cause investors to take a hard look at their asset allocation, and dissuade them from the loser's games of stock picking and market timing.
Investors who are tempted to predict whether or not there will be a recession, and to take action based on that prediction, should be reminded of the observation by Ms. Furchtgott-Roth in a recent article that "economic forecasters were invented to make meteorologists look accurate."
If these highly trained professionals cannot reach a consensus on this critical issue, it is unlikely that you can do so with any confidence.
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