Is the Stage Set for a Recession?
Although all the present economic numbers are fantastic (setting all kinds of records) it pays to look forward and plan for a possible slowdown. If things do fall off there are investment strategies you should implement. Here are some of the tried and true preconditions that classically signal a fall off in economic activity:
- GDP (Gross Domestic Product) has dropped to 1.6% in the second quarter from 5.6% in the first quarter. We have not seen GDP growth below 2% for four or five years.
- The two other housing downturns in the past 30 years were in the 70’s and the 80’s. The downturns last longer than most people dream and the average cycle is three to four years. This downturn began in 2005 and may last into 2008.
This has happened before but only preceding a recession or very dramatic slowdown. - Flat or inverted yield curves only occur before a recession not a slowdown. All rates from three months to 2 years are above long term rates.
A great economic indicator is the activity at Wal-Mart. It reflects the low to middle income sector of the economy. There has been a dramatic reduction in spending by this end of consumers (Note: 2/3rds of GDP is at the consumer level). Another item that could really impact things is a reversal in tax policy by the new Democratic Congress. A major reason for this 3 year run in the stock market was the passage of lower capital gains and dividend tax rates. This new rate was implemented in May 2003 and the market took off starting in June 2003. Any change in this rate would have a serious negative effect.
A recent proposal by the new Congress is to raise the minimum wage. That will raise unit labor costs throughout the economy for everyone. It will have a major impact on profits (which drives your stock market returns). It will impact unemployment and hurt job creation. If you raise the price of labor, business will find a way to use less of it. As a business owner, to maintain profit margins, when a new cost comes in…you either raise prices (inflation catalyst) or cut costs (lay people off). [You do the same thing in your household when an expense goes up]
The new Congress is talking about a windfall tax on oil companies. A windfall tax on anything would be a major negative. The last time this happened was in the Carter administration, it resulted in less exploration and eventually to the dependence we now have on foreign oil. [oil companies only make 7% profit margin; Coca-Cola makes 19%; cigarette companies make 33% and alcohol companies make 65%; Why isn’t there windfall profits tax on these other companies? Hmm!]
What can you look forward to and how do you position yourself if a recession is coming?
- Inflation has pretty much peaked.
- Commodities will continue to be strong.
- The dollar will continue to weaken thus gold and silver will do well.
- The Federal Reserve will begin to drop interest rates in 2007 into 2008 by 200 basis points, thus fixed income investments will do well.
- REITS will do okay.
- Foreign emerging markets will be strong.