Tracking the Bear—and Finding Opportunities

02/07/2008 12:00 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, president of InvesTech Research, made a strong case for a bear market, but he was surprisingly bullish on certain stocks.

We are currently in one of the most aggressive interest-rate easings in history, James Stack told attendees. The last time there were two consecutive discount rate cuts within ten days was in 1914, indicating that the Federal Reserve is currently very scared.

Stack reminded investors that we have just come off of the fifth longest economic expansion in history, with stock market gains of more than 100%, and that the Fed has tried to engineer a soft landing.

But the Fed has successfully engineered a soft landing in only two out of the last ten downturns. Instead, Stack believes that we are currently in a recession. He commented that the Fed has a very poor track record of averting recessions and once it starts raising rates, there’s almost always a recession as well as a bear market.

Stack cited several indicators that he says show we have entered a recession. The index of leading economic indicators has turned negative, unemployment continues to rise, consumer spending has been slipping since last summer, and CEO confidence levels are low.

But the good news is that the Fed’s six discount rate cuts have most likely reduced the severity and duration of the bear market.

The median duration of a bear market is 1.3 years and it generally results in a 20%-to-30% decline in the market. Stack estimated that the current downturn has a 50/50 chance of wearing itself out by the end of this year. And since larger bear markets of the past typically started from much higher levels of overvaluation than we’ve experienced, he doesn’t expect this one to be nearly as severe.

Stack also pointed out that every recession of the last 50 years, headlines announcing its advent have almost always occurred after the downturn was well under way—and at or near the bottom of the bear market. Just a few days before The World Money Show began, the first headlines announcing this recession appeared, indicating to him that we are in the last leg down of the current bear market.

The only wild card is real estate, which Stack declared, has not yet bottomed—and may not for another three-to-four years. He said he expects an additional 10%-to-15% decline in home prices before the worst is over.

Yet he said he’s optimistic about the stock market: For the first time in almost two years, he has raised his allocation to equities. Sectors he finds attractive include utilities, consumer staples, and health care; the ones he considers the highest risk are financials, industrials, consumer discretion, and technology. 

He cautioned investors to avoid bottom fishing or buying momentum stocks in sectors such as financial or homebuilders that have a long way to go before recovery. Instead, he advised them to choose strong companies selling at attractive valuations.

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