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Recession Lingering?
RECESSION LINGERING? MONTHS AHEAD WILL TELL TALE
DAVID J. GORDON
While the administration is blaming recession on the increase in the price of oil, the previously tight monetary policy of the Federal Reserve has had the greatest impact on the business community.
here is little doubt that a recession has hit the United States. Even the Bush administration and the Federal Reserve System have recently admitted that the economy is not running on all eight (or six or four) cylinders. While the administration is blaming recession on the increase in the price of oil, the previously tight monetary policy of the Federal Reserve has had the greatest impact on the business community. Actions of the Fed take about six to 12 months to affect the economy. Fortunately, the Fed began to ease credit conditions last July and significantly accelerated the process in late 1990. This should re-ignite business activity by late 1991 and effectively put an end to the recession. In the meantime, the real gross national product is likely to decline anywhere from 1 percent to 3 percent through the second quarter and growth for all of 1991 should come in at 1 percent or less. The outlook for growth will depend in large part on an increase in consumer and business confidence. The so-called consumer confidence leading indicators appear to have bottomed out following a 30 percent drop coinciding with the occupation of Kuwait. On a positive note, large declines in consumer spending have modestly reversed. Yet another harbinger of stronger national prosperity is a building and pent-up demand for durable goods, which if unleashed would likely fuel an upturn in personal and business spending and confidence. The current recession will produce some pain and discomfort but it does not come without a number of benefits. The most important by products are typically a drop in both inflation and interest rates. Interest rates have moved lower in recent months, and the likelihood that inflation will drop further suggests that the trend of lower rates will continue, albeit modestly. A falling economy and the recent decline in raw material prices are just two of several factors that should enable the Fed to sustain its current JADA, Vol. 122, June 1991
65
policy of “easier credit,” which could move both long- and short term interest rates down an additional Y2 percent to 1 percent before year end. Lower corporate profits typically come along with a recession, and this combination normally spells bad news for stock prices. But it’s important to recognize that the stock market tends to anticipate changes in the economy. In other words, the market has moved and should continue to move higher or lower well ahead of changes in business conditions. During the past eight recessions, stock prices bottomed out and began to move higher anywhere from three to six months prior to the improvement in the economy. This suggests that the economy (and the market) could stabilize and begin a new uptrend sometime during the next four quarters so long as economic conditions recover at midyear as expected. With resolution in the Middle East no longer contingent on active war, the stumbling blocks to this economic and stock market scenario seem to rest squarely on the shoulders of consumer and business spending habits. Rising unemployment, slow (or negative) corporate earnings and personal income growth plus hesitant capital investment are major areas of concern. On the other hand, improving consumer demand and lower inventories could combine to counterbalance these factors and put the economy back on a mildly positive growth track as early as this summer. How does an investor cope with all these uncertainties? One of the first things the
66
JADA, Vol. 122, June 1991
average investor should do is avoid most high-risk investments, especially in the bond area. Dozens of bankruptcies have already occurred. For many corporate sectors, business conditions are likely to get worse before they get better. Changing corporate credit ratings emphasizes the importance of professional portfolio supervision. In short, keen assessment and reguiar review of your portfolio’s risk/reward characteristics is the word of the day. or the fearless investor of substance, “junk bonds” offer higher relative rewards than ever before in history. These investments, due to their inherent credit risks, require thorough portfolio monitoring. Mutual funds, featuring diversification and professional management, can be an excellent way to participate in this market. As always, spreading risk through sound diversification techniques is the key to professional results. A clear risk in bond portfolios comes from interest rate fluctuations. Perhaps the easiest and most practical method of reducing portfolio interest rate risk and commensurate price volatility can be found in the concept of the “laddered bond portfolio.” This astute investment practice allocates fixed-income investments among different maturities. Locking in yields and providing liquidity are two primary goals of this strategy. High-risk stocks should also be avoided. Corporate profits will continue to suffer through the first
half of 1991. It is probably too early to start looking for down-and-out stocks that have already experienced a falloff in earnings. Instead, investors should upgrade their portfolios to include companies that are substantially immune to the business cycle. A number of these issues can be found in the health care, environmental and food-related industries. With the coming of summer, the stock market is expected to heat up and trade around the 3,000 level, recently achieved for the first time in history. The primary fuel, plain and simple, is money. The PA percent or so yield decline of money market funds in the first months of this year is highlighted by the recent rise in long-term rates from 7.9 percent to 8.3 percent. Given the tendency for longerterm market risk to increase with rises in long-term interest rates, a balanced approach to investingone that balances fundamental risk with a strong market—should be favored. The classical method of balance is to buy either safe stocks or those that are not yet fully appreciated or valued by the investment community. ■ Mr. Gordon is an investment adviser in the Northbrook, 111., office of Blunt Ellis & Loewi, a division of Kemper Securities Group, Inc. The views expressed here are those of the authors and may not reflect the opinion or policy of the ADA or its subsidiaries. Before acting on the advice offered here, dentists should consult their own attorneys, accountants or advisers.
DAVID J. GORDON
While the administration is blaming recession on the increase in the price of oil, the previously tight monetary policy of the Federal Reserve has had the greatest impact on the business community.
here is little doubt that a recession has hit the United States. Even the Bush administration and the Federal Reserve System have recently admitted that the economy is not running on all eight (or six or four) cylinders. While the administration is blaming recession on the increase in the price of oil, the previously tight monetary policy of the Federal Reserve has had the greatest impact on the business community. Actions of the Fed take about six to 12 months to affect the economy. Fortunately, the Fed began to ease credit conditions last July and significantly accelerated the process in late 1990. This should re-ignite business activity by late 1991 and effectively put an end to the recession. In the meantime, the real gross national product is likely to decline anywhere from 1 percent to 3 percent through the second quarter and growth for all of 1991 should come in at 1 percent or less. The outlook for growth will depend in large part on an increase in consumer and business confidence. The so-called consumer confidence leading indicators appear to have bottomed out following a 30 percent drop coinciding with the occupation of Kuwait. On a positive note, large declines in consumer spending have modestly reversed. Yet another harbinger of stronger national prosperity is a building and pent-up demand for durable goods, which if unleashed would likely fuel an upturn in personal and business spending and confidence. The current recession will produce some pain and discomfort but it does not come without a number of benefits. The most important by products are typically a drop in both inflation and interest rates. Interest rates have moved lower in recent months, and the likelihood that inflation will drop further suggests that the trend of lower rates will continue, albeit modestly. A falling economy and the recent decline in raw material prices are just two of several factors that should enable the Fed to sustain its current JADA, Vol. 122, June 1991
65
policy of “easier credit,” which could move both long- and short term interest rates down an additional Y2 percent to 1 percent before year end. Lower corporate profits typically come along with a recession, and this combination normally spells bad news for stock prices. But it’s important to recognize that the stock market tends to anticipate changes in the economy. In other words, the market has moved and should continue to move higher or lower well ahead of changes in business conditions. During the past eight recessions, stock prices bottomed out and began to move higher anywhere from three to six months prior to the improvement in the economy. This suggests that the economy (and the market) could stabilize and begin a new uptrend sometime during the next four quarters so long as economic conditions recover at midyear as expected. With resolution in the Middle East no longer contingent on active war, the stumbling blocks to this economic and stock market scenario seem to rest squarely on the shoulders of consumer and business spending habits. Rising unemployment, slow (or negative) corporate earnings and personal income growth plus hesitant capital investment are major areas of concern. On the other hand, improving consumer demand and lower inventories could combine to counterbalance these factors and put the economy back on a mildly positive growth track as early as this summer. How does an investor cope with all these uncertainties? One of the first things the
66
JADA, Vol. 122, June 1991
average investor should do is avoid most high-risk investments, especially in the bond area. Dozens of bankruptcies have already occurred. For many corporate sectors, business conditions are likely to get worse before they get better. Changing corporate credit ratings emphasizes the importance of professional portfolio supervision. In short, keen assessment and reguiar review of your portfolio’s risk/reward characteristics is the word of the day. or the fearless investor of substance, “junk bonds” offer higher relative rewards than ever before in history. These investments, due to their inherent credit risks, require thorough portfolio monitoring. Mutual funds, featuring diversification and professional management, can be an excellent way to participate in this market. As always, spreading risk through sound diversification techniques is the key to professional results. A clear risk in bond portfolios comes from interest rate fluctuations. Perhaps the easiest and most practical method of reducing portfolio interest rate risk and commensurate price volatility can be found in the concept of the “laddered bond portfolio.” This astute investment practice allocates fixed-income investments among different maturities. Locking in yields and providing liquidity are two primary goals of this strategy. High-risk stocks should also be avoided. Corporate profits will continue to suffer through the first
half of 1991. It is probably too early to start looking for down-and-out stocks that have already experienced a falloff in earnings. Instead, investors should upgrade their portfolios to include companies that are substantially immune to the business cycle. A number of these issues can be found in the health care, environmental and food-related industries. With the coming of summer, the stock market is expected to heat up and trade around the 3,000 level, recently achieved for the first time in history. The primary fuel, plain and simple, is money. The PA percent or so yield decline of money market funds in the first months of this year is highlighted by the recent rise in long-term rates from 7.9 percent to 8.3 percent. Given the tendency for longerterm market risk to increase with rises in long-term interest rates, a balanced approach to investingone that balances fundamental risk with a strong market—should be favored. The classical method of balance is to buy either safe stocks or those that are not yet fully appreciated or valued by the investment community. ■ Mr. Gordon is an investment adviser in the Northbrook, 111., office of Blunt Ellis & Loewi, a division of Kemper Securities Group, Inc. The views expressed here are those of the authors and may not reflect the opinion or policy of the ADA or its subsidiaries. Before acting on the advice offered here, dentists should consult their own attorneys, accountants or advisers.