Does Recession Point to a Bottom?

12/24/2008 10:00 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, editor of InvesTech Research, says this recession may be one of the longest on record, but it may be time to look for signs of a market bottom.

Well, it's now official: The US economy is in a recession!

And the distinguished group of economists with the revered responsibility of establishing the official starting date has set it—as we predicted—in December of last year.

Ironically, in three of the past four recessions, this formal recognition of a recession by the National Bureau of Economic Research (NBER) has coincided almost exactly with the end of the recession. (Yes, they truly are that late!)

While this announcement may not coincide with the end of recession this time around, it should at least force Ben Bernanke and the Federal Reserve to start using the "R" word in describing the current economic crisis and challenges ahead.

And whether one looks at the big-cap Standard & Poor's 500 index, the broad Wilshire 5000 Index, the small-cap Russell 2000 Index, or the technology-laden Nasdaq Composite index, this has been a "generational" bear market with maximum losses now exceeding 50% across the board.

In short, there has been no place to hide!

From a longer-term perspective, it has been the largest bear market since the 1930s for the S&P 500 Index, with a loss now exceeding 51%. Only the 1929-1932 bear market has been notably more severe for investors—and that 86% loss was spread over three years, not 14 months, as in the current case.

If the current recession were to extend through the middle of next year, it would become the longest recession since 1933. And if it were to extend through the end of 2009, as some gloomy prognosticators are suggesting, it would then become the second longest recession in over 100 years!

We're not saying that is an impossibility. But we seriously doubt that the current recession will extend through the end of next year. And if it were to end some time in the first half of 2009, then it's certainly not too late to be looking for a stock market bottom, since the stock market typically leads the economy by six to nine months.

With a new $700-billion bailout program, plus a few extra trillion dollars of guarantees, the Fed, Treasury, and Congress now seem to be paddling in the same direction. Their effectiveness has improved liquidity, even if it cannot create a bottom in the housing market.

Our portfolio remains defensively allocated, with a 42% cash reserve. However, watch for two possible bullish developments over the weeks ahead that might compel us to add portfolio positions. First, from a fundamental viewpoint, look for any upturn in consumer confidence—particularly in "future expectations"—to be released on December 30th.

And second, from a technical standpoint, watch for any hint of a bullish "Selling Vacuum" (a sudden drop in selling of stocks). That is often the earliest confirmation of a market bottom and often appears within the first two months after the low has been hit.

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