A Depression, or Just a Bad Mood?

July 12, 2009 | By Joel Schlesinger

The green shoots of economic recovery are looking more withered and yellow by the day. The surge in stock prices that began March 9 appears to be over, and it's not just the experts who think the stock market's 30 to 40 per cent upswing was a false start, finance Prof. Robert Ironside says.

"I recently gave a talk to clients with the Bank of Montreal called 'Green Shoots or Suckers' Rally?' and I asked the audience whether they thought this market was a suckers' rally," says Ironside, a professor at Kwantlen Polytechnic University School of Business in Vancouver.

"About 90 per cent of them indicated they thought it was a suckers' rally."

Although average investors are likely basing their predictions somewhat on their gut feelings, Ironside says many experts are validating those instincts with a bleak overall economic outlook.

"What (experts) are saying is what we are seeing today is actually worse than what we saw in the early '30s," he says.

Ironside points to investment analysis guru John Mauldin's website, Thoughts From the Frontline, which features a weekly enewsletter Outside the Box, for further explanation.

In recent weeks, the newsletter has included several commentaries by some of the investment world's leading analysts and economists -- all skeptical of the notion a recovery is coming soon. Among them is a June 29th column by David Galland, managing editor of the Casey Report, which discusses the views of economic historian Neil Howe.

Howe co-authored with fellow historian William Strauss the 1997 book titled The Fourth Turning, which theorized that Anglo-American history follows a series of generational movements lasting about 80 years each, broken down into four 20-year stages.

Howe contends we are in the midst of a "fourth turning," the end of a cycle that began after the Second World War. He compares our current predicament to the period spanning the Great Depression and the Second World War, the fourth and final stage of the historical cycle previous to this one.

Every fourth turning or cycle's end has been marked by instability and fundamental political, social and economic change. (The American War of Independence and the Civil War occurred at the end of 80-year periods.)

On a scale of one to 10, with 10 representing how bad economic conditions will get, Howe says he believes we're at about two or three, and circumstances should get much worse over about a 20-year period before they get better.

It's a gloomy prediction that certainly mows down any remaining green-shoots enthusiasm, but the dire forecast doesn't mean investors should start stuffing money under the mattress.

Edward Jones economist and analyst Kate Warne says the grim prognosis -- at least for the recent mini-bull market -- isn't as bad as we might think. The uptick over the last few months is still a good sign because it is an indication that the rate at which the economy is contracting is slowing.

"That obviously has to happen by the nature of physics -- not economics -- before we see growth resume," she says.

"Some of the hottest sectors, in our view, have been energy and commodities, and those are areas we would be a bit cautious about right now because we do think their prices have run ahead of some of the fundamentals."

Yet investors don't have to steer clear of commodity companies altogether.

"In particular, if you want to put money to work in those areas, we suggest you do dollar-cost averaging."

For those looking to invest a bigger chunk of cash at once instead of investing smaller, set amounts each month, Warne says other stocks might fit the bill because they have not increased in price as quickly.

They are less exposed to being hit by a correction, which she says is likely inevitable as the summer progresses and quarterly reports trickle out with expected lacklustre earnings.

Furthermore, investors who saw gains in energy and other commodity stocks over the last few months should take the profits, she suggests.

And they should think about reinvesting the money into sectors not as likely to be hit as hard when the bear market returns.

Investors should consider utility companies, telecoms and some consumer staple stocks (like Wal-Mart) because they are not likely as overpriced as energy stocks, and some have even been able to increase their dividend payments amid the economic malaise.

Any investment offering good, stable payments like dividends is desirable at this juncture, says Doug Nelson, an adviser with Nelson Financial Consultants in Winnipeg.

"My very strong bias today would be I don't want to look at it unless it's going to pay me to hold it," he says.

Look for investments that offer higher yields, such as dividend-paying stock, bonds or income trusts. But he warns not to get caught up chasing yield.

"If something pays too much -- like a 12 or 15 per cent yield -- that's obviously an indication of risk," he says, adding preferred shares are his preference at the moment.

"The banks with their issues in that category are producing six to seven per cent dividends and are considered to be reasonably safe," he says, adding they could produce a 30 to 40 per cent return over the next five years.

Warne says she can understand the attraction to preferreds, particularly because of their dividend tax efficiency.

But she recommends instead a different strategy using a combination of undervalued stock, such as utilities, and corporate bonds, which she says are overlooked and offer almost as good yields as the preferreds.

"What we are saying is take a little less income now," she says. "What you will get over time is the price appreciation on the stock, an increase in the dividend, and you'll probably have more in the future than what you would have with the preferred."

Regardless of strategy, both Warne and Nelson emphasize investors should not worry about the short-term direction of the market. It's the long-term trend that's important.

"It all comes down to painting a story that you think has a reasonably good probability of success," Nelson says, cautioning that investors need to keep portfolios diversified to avoid overweighting in one specific sector.

"You have to take a reasonable risk to get a reasonable yield, but you don't want to bet the farm on it."