Don’t Overuse the “R” Word

01/10/2008 12:00 am EST

Focus: MARKETS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Dan Wiener, editor of the Independent Adviser for Vanguard Investors, tells why he doesn’t see a recession or bear market coming.

Unless you’ve been hiding under a rock these past few months, you’ve probably heard the “R” word with increasing frequency. But just what is it? The simple and time-worn definition of a recession is a period in which there are at least two back-to-back quarters of negative GDP growth. In other words, it’s when the economy shrinks, or recedes.

However, the National Bureau of Economic Research, the official arbiter of recessions, considers a recession to have occurred when there has been a “sig­nificant” decline in real income, employment, industrial production, and wholesale and retail sales running for at least six months to a year. There is absolutely no way to know a recession has hit us until the data, which is at least a month or two old, are collected and disseminated.

We could be in the beginnings of a recession right now, though I don’t think that’s the case. Industrial production is certainly slowing—the last reading, for November, showed a gain of 0.3%, though this followed a decline in October of 0.7% and was better than economists had expect­ed.

Real income growth is also slowing but remains positive, and has been in every month but one (April 2007) over the past two years. Plus, new jobs continue to be created, though again at a slower pace than in recent months. And the unemployment rate remains at a fairly low level.

The bottom line is that recessions are tough to predict. Even the NBER didn’t affirm the beginning of the 1990-91 recession until one month after it had already ended. So, bring some healthy skepticism to the table when the pundits absolutely, positively claim that we are in, or about to head into, a recession.

Remember that if they are wrong, no one will be reminding us of it in another year, but if they are right, you’ll be hearing about it for years to come. Before you open your next newspaper or turn to the financial channels, stock up on several large grains of salt. You’ll need ‘em.

My bottom line is that there’s plenty that needs fixing in the US economy, and in particular in the banking and housing sectors, which are huge. But a ton of risk has been washed out of the markets, and we’ve still earned 3.8% to 12.1% returns for the year. No, it wasn’t gangbusters, but unlike a lot of those fancy-pants hedge funds and private equity funds, we didn’t lose our shirts, either.

Do I have worries? Plenty. But most­ly I worry about unbridled pessimism that is based in emotions rather than reality. I certainly don’t see a nasty bear market on the horizon. A 10% correction? Absolutely. We’ve already had one, or more in selective parts of the US stock market, and more are surely on their way: Expect at least two before June. But a 25% or 30% decline? I don’t see it.

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