Batten Down the Hatches

01/21/2008 12:00 am EST

Focus: MARKETS

Tobin Smith

Founder and Chief Research Analyst, NBT Equity Group

Tobin Smith, chairman of ChangeWave Research and a raging bull on stocks, now shifts gears and declares that we are in a recession and investors need to get defensive.

The evidence has been building that we are in a recession.

And according to all of the indicators I study, this won't be a drive-by recession like the one we experienced in 2002.

According to our latest ChangeWave Alliance consumer spending survey, in the next 90 days there will be a decidedly negative growth rate. The decline in spending growth is occurring across all income levels. The rapid deterioration of our Alliance super-spenders’ (respondents who earn more than $150,000 per year) outlook for the first 90 days of 2008 is particularly alarming.

We also found that 56% of survey respondents now think the overall direction of the economy is going to worsen in the next 90 days. That's a HUGE 18-point jump since November.

All four key barometers used by the National Bureau of Economic Research—employment, real personal income, industrial production, and real sales activity in retail and manufacturing—are negative.

The US economy is stalled, and without another historic set of interest rate cuts by the Federal Reserve and another round of big tax cuts, we are likely going to continue crawling.

[Federal Reserve chairman Ben] Bernanke should realize that only an immediate 50-basis point cut, and then another one following in rapid succession, will give the economy a fighting chance.

Of course, the Fed won't act in such dramatic fashion, first because it can't, and second because it would lose all credibility regarding its inflation-fighting bona fides. Basically, the Fed is stuck with conventional-warfare tactics in what has now become an unconventional market slowdown.

The following are my "big picture" plans for dealing with our current situation.

1. Turn down the risk. This means shedding most high P/E stocks (over 35x-40x) or high- risk/blue-sky stocks that get crushed in the P/E contraction that precedes recessions.

2. Hold some cash. Make sure you have plenty of liquidity to take advantage of compelling opportunities from the recessionary fallout.

3. Lower “Buy Under” prices. Most solid secular growth stocks that have earnings and revenue growth locked in due to worldwide transformational change—i.e., alternative energy leaders, Apple (NASDAQ: AAPL), and biotechnology plays—will likely come down with the rest of the market. This short-term pullback will require a retooling of many of our Buy Under prices.

4. Add cost-cutting health care/medical-product secular growth plays. This is the ONE part of the economy that, because of sheer demographics alone, will substantially outgrow the overall economy.

5. Convert our Cash Generator portfolio to a "defensive portfolio". This means building up to a 50% position in stocks that benefit from the recession—stocks that grow earnings as short-term interest rates drop and/or recessionary activities grow (for example, bankruptcy services and corporate work-out providers).

This isn't a time for wholesale panic selling. Many of our recommended stocks will be higher later in 2008 than they are today. But you must be prepared for a tough market in the days ahead.

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