Will We Dodge Recession’s Bullet?

12/10/2007 12:00 am EST


Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, Standard & Poor’s chief investment strategist, says we’ll probably avoid a textbook recession, but names some sectors that might be attractive if a downturn occurs.

Economic recessions are contractions in growth identified by the Business Cycle Dating Committee of the National Bureau of Economic Research, usually well after the fact. Arthur Okun, an economic advisor to Presidents Kennedy and Johnson, established the rule of thumb that says two successive quarters of real gross domestic product (GDP) declines signal a recession.

Since 1945, there have been 11 recessions occurring every 5.5 years, on average. The longest stretch between recessions was the 128 months separating the 1990 and 2001 recessions. The shortest was in the early 1980s, with only 18 months between them. On average, recessions have lasted a little more than ten months.

In all, the average loss in the value of equity prices during recessions since World War II was 26% for the Standard & Poor’s 500. The decline in US equity prices during these periods may also have largely influenced the average decline of 23% for the MSCI-EAFE index (a benchmark of large multinational companies in developed nations).

On a sector level, we found that there was no place to take cover—on average, all ten sectors in the S&P 500 posted a decline. The smallest declines were recorded by the traditionally defensive sectors of consumer staples, health care and utilities. The worst performers were industrials, materials, consumer discretionary, and energy. At the industry level, only three groups posted positive returns over the ten periods: tobacco, household products, and alcoholic beverages.

There have been 11 recessions since 1945, but also 49 pullbacks, 16 corrections, and ten bear markets. Therefore 64 of these 75 market sell offs incorrectly anticipated the 11 eventual recessions. Pullbacks typically recovered in about two months, while corrections reversed themselves in fewer than four months. So, it’s imperative to be confident of a recession before calling for defensive posturing.

We’re not there yet. S&P sees economic weakness ahead but not a recession. We forecast US real GDP growth to decline from the 4.9% pace recorded in the third quarter of 2007 to a 0.6% growth rate in the first quarter of 2008, book-ended by 1.4% growth in the fourth quarter of 2007 and a 1.5% advance in the second quarter of 2008.
We also believe a proactive Federal Reserve will help the United States avoid recession. The Fed has cut the discount rate three times and the Fed funds rate twice. We think the Fed’s recent statement was tough, but S&P Economics expects the weakness in the economy to force another rate cut, most likely in December. The Fed is right to be concerned about inflation, in our view, especially given the falling dollar and its impact on consumer prices. But in the short run, we see recession as the bigger risk.

Investors who would rather not wait for a [recession] signal could increase their exposure to exchange traded funds that emulate the performance of traditionally defensive sectors:
Select Sector SPDR-Consumer Staples (AMEX: XLP), Select Sector SPDR Health
Care (AMEX: XLV), and Select Sector SPDR-Utilities (AMEX: XLU).

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