Beware the Second Leg of the Next Great Recession

There's no doubt that there are green shoots in the economy. The housing market, which brought on the crash, may finally be starting to recover. Housing stats bottomed in January, and it looks like the rate of decline of housing prices is slowing. Volumes are rising at MasterCard (NYSE: MA  ) and appear more or less stable at Visa (NYSE: V  ) . And corporate earnings aren't as big a disaster as everyone thought they'd be.

But now is not the time to be complacent.

Delusions of grandeur
Unfortunately, there's been very little evidence of a solid recovery. Sure, the financial crisis seems to be past, and the economy didn't collapse. After the turmoil that followed Lehman's failure, the government's quick actions to shore up the financial sector have convinced people that the government won't let another big bank fail. Consequently, the sheer terror we experienced last fall has faded to mere paranoia.

But beyond that, it's unclear when the real economy will recover. America's Gross Domestic Product (GDP) was plummeting, and it now seems to be flattening out, but that isn't a great indicator of a recovery. It's almost inevitable that, without a complete financial collapse, GDP won't keep shrinking for long. A big part of the decline in GDP has been from inventories, which have been plummeting since October last year. But, manufacturers eventually have to increase output, or they'll run out of widgets to sell, and that boosts GDP figures.

What's more, the government has been throwing money at the economy to try to reverse the vicious cycle of layoffs resulting in lower corporate sales, which is leading to more layoffs. This, too, props up GDP, so it's not really surprising that GDP seems to have bottomed.

The key to recovery
But funding a recovery with huge government spending and massive debt is like using a defibrillator to treat a heart attack. It can work well in short doses, but it's completely unsustainable over the long term. Maybe General Motors, Ford, and Toyota (NYSE: TM  ) aren't complaining about the 30% boost to car sales in August as a result of the Cash for Clunkers program. But does anyone really believe that demand will be sustained through the end of the year?

The government isn't the key to recovery. Neither are corporations. Consumer spending is what really matters, accounting for 70% of the GDP. But right now, consumers are acting as cheap as a Congressman who has to spend his own money.

Americans seem to have finally realized that taking on third mortgage to buy a second 74-inch TV for the bathroom is not a sensible decision. Household debt, which has been steadily rising since the 1950s, has actually started to decline. And consumer confidence, while improving, only looks good when you compare it to the all-time lows it hit in February.

But why should consumers be confident? The unemployment rate is 9.5%, just off a 26-year high. As if that weren't bad enough, 1.3 million Americans could exhaust their unemployment benefits before the end of the year.

And you expect consumers to help the economy rebound? Good luck with that.

Mixed messages
Insiders are nervous -- according to TrimTabs, the ratio of insider selling to buying in August exceeded 30, the highest level since TrimTabs started measuring the statistic in 2004. Companies as diverse as General Electric (NYSE: GE  ) , UnitedHealth Group (NYSE: UNH  ) , Google (Nasdaq: GOOG  ) , and Sirius XM (Nasdaq: SIRI  ) participated in the recent spate of insider selling.

But despite all these problems, it's still hard to form a firm conclusion. Employment is a lagging indicator -- companies hire when they need workers, not because they think that there's a chance they'll need workers next year. And insiders, like other investors, may simply be taking advantage of the huge bounce since March. Maybe we just need to wait, and those green shoots will blossom. If everything looked bright and cheery, it would hardly be the Great Recession now, would it?

It's a very confusing environment in which to be an investor. If this is the start of a recovery, the market could still run another 50% before testing the old highs. So scaling back your portfolio doesn't make sense. But if this is just an economic head fake, do you really want to relive the last few months of 2008?

The solution is to focus on value stocks. Value investing really shines right now, because it provides the best of both worlds. If you can buy a stock for 50% of its fair value, you make a 100% return if the stock returns to more rational pricing. But, since stocks tend to gravitate toward a fair price, value stocks can also cushion your portfolio during a bear market. You can get the upside, with less downside risk.

The Foolish bottom line
Our Inside Value newsletter has illustrated these benefits nicely. Since 2004 -- including the massive plunge last September to March -- this newsletter's recommendations outperformed the market by over 5 percentage points per pick.

It's that combination of excellent upside with a reduced downside that makes value stocks so compelling right now. If you'd like to read about our top picks, we're offering a free trial to Inside Value.

Fool contributor Richard Gibbons collects things that gravitate. He owns shares of Google, a Rule Breakers recommendation, and UnitedHealth Group. UnitedHealth Group is both an Inside Value and a Stock Advisor selection, as well as a Fool holding. The Fool's disclosure policy will rock you like a hurricane.


Read/Post Comments (15) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 18, 2009, at 12:04 PM, phloid01 wrote:

    Fear and uncertainty, a tragic combination which this article has done a great job of replanting into anyone which reads it. These are the tactics of failure. Yes, it is easy to illustrate the problem, but the real challenge is to show the value of experiencing the tough issues we face today, and how we are taking steps to resolve them. The government throwing money is not the long term solution, correct, but the only real solution is people being confident and willing to spend. And the only LONG TERM real solution is that same confidence being used, with a high grade of smarts in how they spend. Please STOP PROBLEM ILLUSTRATION, and begin to spread more confidence. That is how we all get out of this, not by creating fear without any true path ahead. That is what got us into this.

  • Report this Comment On October 18, 2009, at 12:19 PM, aliant04 wrote:

    phloid01

    Yes that's right BS your way to profits. Don't in any way be negative and hopefully just hopefully no one will notice that the great depression is still here.

    Man, you make the cake.

    It is truth that doesn't matter in the shell game you all play.

    Well the good news is, the US is toast and finally we end the era that allows the stupids to prevail.

  • Report this Comment On October 18, 2009, at 12:33 PM, cdelaney08 wrote:

    phloid01,

    Sorry but that just makes no sense. If all we had to do was close our eyes, tap our heels together, and say to ourselves "The economy will be strong! The economy will be strong!" then we could just ignore our credit card statements, ignore the fact that so many are out of work and this is continuing to rise, ignore the massive debt being stockpiled by both gov't and consumers, ignore the falling dollar and future inflation from a growing money supply, ignore the fact that credit is hard to come by, etc etc etc ignore all this and just collectively start buying things!!! Oh yea, that'll work. It will put us FARTHER into debt and exacerbate the problem and cause a bigger crash down the road. Wake up from the dream. Face reality. You can't WISH your way out of a recession.

  • Report this Comment On October 18, 2009, at 12:33 PM, mountain8 wrote:

    This isn't truth. It's opinion.

  • Report this Comment On October 18, 2009, at 2:57 PM, cooper222 wrote:

    A value stock is not what an investor needs to survive this recession. A company with strong earnings and revenue growth will do well. Value stocks are cheap for a reason and represent a trap for investors.

  • Report this Comment On October 18, 2009, at 6:14 PM, JTremper wrote:

    I'm sure most people would prefer to hear good news that restores confidence. The problem is economics as a science is almost never good news: it's been called the dismal science because it tends to measure the scarcity of resources. Take "unemployment": how many of us might be more encouraged to think in terms of 84% employment, meaning that a clear majority of people are indeed working? But to make it newsworthy we publish unemployment numbers and focus on the scarcity of jobs. So we need to interpret the news and use it properly without overreacting at every headline that says the sky is falling.

    Respectfully submitted.

  • Report this Comment On October 18, 2009, at 6:38 PM, prose976 wrote:

    One thing greatly overlooked by most:

    Perhaps the "crash" was bull scat, and the consolidation of business and the cutting of fat from payrolls and government is actually very good for the economy. Hence, the "recovery" is being justified, but is actually just a return to reality.

    The market is about where it should be, perhaps.

    Maybe we're exactly where we should really be...even with the unemployment levels as high as they are. While many may wish this wasn't true, and that we should really be at Dow 6000 or less, with the dollar going down in value, interest rates in the toilet and gold bubbling, a much better place to put your "money" is into something - a real asset that actually does something for you personally or for other people in your state, country or across the globe.

    The market does not reflect the economy, but instead it reflect economics of the market ecosystem. Efficient companies are worth more than inefficient companies inherently.

    Here's an example of how people have looked at the market in the past.

    The market was lean an mean for many years. Then it became bloated, as did spending by the companies that composed the market. But that bloating was recognized as valuable, because those companies were displaying "prosperous" window dressing in the form of buying more than was needed, hiring more than were needed, stocking more than was needed, paying more dividends than made sense, etc.

    Smart companies have taken the opportunity to "get fit" over the last year or two. This has made them more valuable, especially because they are still able to meet demand, innovate and also because the world is not shrinking, which gives them even more opportunity. Conversely, current business competition IS shrinking, thus giving greater market share to the standing, more efficient companies who made it out alive.

    The market companies are leveraging the long tail (read about it in Wikipedia). There is a lower common denominator. If you can't sell a $100 item to 100 people then sell a $10 item to 1,000 people. With technology, it can be done, and is being done. That's why Tech has led this thing.

    I think we're fairly valued and may spend a long while between Dow 9000 and 12000, but it is very likely we could even push past our beginning 14000 because of the new value companies are bringing, not in jobs but in solid, upward trending revenues that has been enabled by the global technology revolution.

    Fool on!

  • Report this Comment On October 18, 2009, at 7:26 PM, 11x wrote:

    Predicting the economy is futile. Your best bet is to dollar cost average at all times.

  • Report this Comment On October 18, 2009, at 8:50 PM, brandonmatthews wrote:

    Best Motley Fool article I've ever read.

  • Report this Comment On October 18, 2009, at 9:02 PM, SIRIDoom wrote:

    Manipulation is a fact.

    Thousands of ways exist to manipulate stocks. But, none of them matter in a controlled market.

    1. The United States Government handed control of all financials to the FED and Goldman Sacks in the first "Bush" Bail Out.

    2. SIRI is controlled by Goldman Sachs by contract and loan with stock LEAN guarantee. Goldman Sachs uses that LEAN to barrow shares to short a hedge on the loan. That hedge has amassed billions in share traded in profit for Goldman Sachs.

    Believe what ever you need to believe. We as retail investors are like sheep being slaughtered. The Government has our balls. Goldman Sachs has everything else.

    For SIRI it is all an inside deal. Mel needs to reduce the stock issue and he will let Goldman Sachs keep SIRI trading under the dollar. After we get milked a few more times while they make it all look good, the rev-split will happen.

    It was all planned... No reason to argue… Just wait and see…

  • Report this Comment On October 18, 2009, at 10:02 PM, stan8331 wrote:

    For the life of me I can't understand why anyone would want to bet everything on a prediction of where the market will go in the short or medium term - bull or bear. Only the bunker-buyers would plan on the market going to zero over the long-term. What makes sense to me is to stay invested AND keep a healthy portion of cash on hand.

    Buy more when valuations look cheap due to panic selling, lighten up some when valuations get high due to panic buying. Betting the farm on a prediction MIGHT pan out, but lacking the absolute faith in my own predictive abilities that many other folks seem to possess, I prefer to take a moderate route that allows me to sleep at night.

    I've also never really understood making a bright distinction between value and growth stocks. Always seemed to me that the smartest plan is to ignore artificial labels and just look for good values in stocks that you anticipate to exhibit strong growth.

  • Report this Comment On October 18, 2009, at 10:28 PM, hsmom2004 wrote:

    Regarding corporate bloat, the Wall Street Journal was warning people about the corporate bloat, unreasonable wages and retirement packages for CEOs and other corporate execs, and golden parachutes that took huge tolls on corporate finances and retirements for employees long before the government stepped in. I guess shareholders did not read those articles to take the corporations to task over this - or were so content with the large dividends, that they did not recognize the costs to them in the long run of poorly managed finances.

    401Ks were a nice idea, in theory, I suppose, but certainly not wise. This just allowed corporations to no longer provide pensions to employees. When corporations fell so in the late '80s, this could have seemed like a way to ensure that people would have something for retirement. The dilemma is that a large number of those people do not understand stocks well enough to make informed decisions or are very limited in their options. For some civil service workers, their retirement programs are managed for them and they have no say-so whatsoever in where to invest and how.

    Much advice given out by investment advisors is poor. I've dealt with a number of different advisos and am glad I did not listen to their advice because I didn't lose my shirt during the first free-fall in 2000/2001 and have not since, while others around me did. (One advisor told me to hold my shares of a certain stock because it had maintained 65% year-over-year growth for a number of years. Anyone with any sense can tell that is not maintainable and the company was showing signs of stress in trying to maintain growth. I followed my own sense after watching the cycles for this company year after year and got out at $114 after a peak of $121. The stock tanked directly thereafter and has never recovered.)

    The poorly conceived bank bail-outs and other corporate bail-outs at the cost of trillions of dollars to tax payers is ridiculous. If the businesses fail, they fail. Nobody wants our banks to fail because our only "value" in our dollar is consumer confidence in it and the value other countries perceive in our strength, yet the government is doing all it can as quickly as possible to devastate what value remains anyway, so what of it if the banks failed? The biggest concern I had that I sent to my congress representatives was that it was ill-conceived and no requirements were included on the way the bail-out would be implemented. I received letters stating why it was a needed strategy from each of them and their assurances in the letters that it would be aptly managed to ensure no abuses. Yeah, right.

    There is no point saving money in banks - the FED has assured that interest rates are maintained at ridiculously low levels for years. What were they loaning money with anyway since nobody with any sense (or cents) is keeping their money in a bank? (rhetorical)

    To truly grow the GDP, there has to be consumer confidence. Right now, the only confidence we have is that government will get bigger, our tax debt larger, and the US dollar will become near worthless before it's all said and done.

    Investors must be wise enough to use their proxies to require good management of corporate funds, but when 401Ks and ESPPs cause an unusually high number of investors in large companies due to their own employees being shareholders who aren't going to speak up about poor management issues and outside investors who only care about large dividends, stocks will continue to be an unwise place to invest for retirement purposes. Continuing this trend will only create more over-the-top high and devastatingly low cycles in the stock market with no real stability or true assesment of "fair value" for stocks.

  • Report this Comment On October 19, 2009, at 2:37 AM, SIRIDoom wrote:

    The Seasaw

    Asia - Go up

    Europe - Go down

    US DOW - Go up

    The EU and World Bank have our nuts in a vice...

  • Report this Comment On October 19, 2009, at 7:54 AM, SIRIDoom wrote:

    On this day in 1987

    Black Monday

    Monday, October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short time. The crash began in Hong Kong.

  • Report this Comment On October 20, 2009, at 11:09 AM, georcole wrote:

    "Everyone should complain to MF about the spam advertising Seeking Alpha and Statwaves." That quote is from the biggest spammer out there- SIRIDoom.

    I do not know or care about SIRI too much. As far as I am concerned, it is much too speculative for me to consider putting money into. However, I find it rather funny that SIRIDoom is constantly talking about Seeking Alpha and Statwaves. I see it as advertising for them. The more SIRIDoom mentions them, the more people are going to go to those sites and check them out, whether that is the intention or not.

    SIRIDoom, maybe just say something to the effect of "there are other sites out there" instead of naming them. Otherwise it looks like you are advertising for them. Negative advertising is still advertising.

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