If It Walks and Growls Like a Bear…

09/06/2007 12:00 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, president of InvesTech Research, weighs the chances that we're entering a recession or a new bear market.

Historically, bear markets are far more likely to start in the first or second year of a presidential term. The reason is that bear markets and recessions tend to go hand in hand, and no one wants the economy dropping into recession heading into an election.

We're currently in Year 3 of the presidential election cycle, and since 1920 only one bear market started in this time frame-the 1987 Crash. So right there, the odds of a bear market are greatly reduced (at least, if the politicians and Federal Reserve have their way).

As market historians and devout Fed watchers, we are also the first to say that Fed policy can, and usually does play a major role in the timing, severity, and duration of bear markets. In short, nothing soothes a falling market faster than easy money (that is, most of the time).

[Since 1929], deflationary bear markets were the exception to the norm, as bear markets in 1929, 1932 and 2001 all saw the market significantly lower 12 months later. (Yes, the 2001 bear market was deflationary, as the popped bubble on Wall Street wiped out $7 trillion in investor wealth.)

Of the past five instances of Fed easing, only one saw the Standard & Poor's 500 over 1% higher in the first six weeks after the first rate cut. Since the S&P 500 index has already rallied over 3% since [the August 17th discount] rate cut, we have likely seen most of the positive effect of this rate cut over the near term.

In the two instances (in 1967 and 1968), where the rate cuts stopped after just one, the stock market struggled through the following 12 months without much change for the bulls. or the bears.

Most [bear markets] last between 12 and 20 months (1.0 to 1.7 years). The 1987 Crash and 1990 bear market were notable exceptions, at only 3 months each. And the 2?-year bear market just experienced (from early 2000 until late 2002) was the longest in 60 years. So, even if we have entered a bear market, we could see a new buying opportunity appear before next year's election.

Recessions are never planned. In fact, we do not know of a single one that was forecast in advance by any poll of economists. Despite the reluctance of economists and Federal Reserve officials to use, or even mention, the "R" word, the odds have risen.

We should note, however, that the widely-respected economic researchers at ECRI (Economic Cycle Research Institute) have no such reservations. "Though the longer-term US economic growth outlook has faded somewhat, a recession is not in sight."These guys are good. Their models tend to be very reliable. Yet we know that stock prices often lead economic warning flags, and the unwinding of the housing bubble has an added element of risk to it.

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