Could the Next Bear Be a Cub?

05/08/2013 8:30 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

When the economy and markets finally succumb to the cycle and drop, it's unlikely that the hard times will be nearly as bad as in 2000 and 2008, for one simple reason, says Jim Stack.

The economy is on our minds today, and my guest is Jim Stack. Hi Jim, thanks for being here.

It’s good to talk to you, Nancy.

So we’ve had a lot of people now talking about how we might be going into a recession again. Other people are saying absolutely not. So what’s your view?

That’s the great debate: whether or not we’re going into a recession. There’s a lot of macroeconomic evidence that has slowed down. The ISM survey for manufacturing has slowed down to 50, which is right between expansion and contraction...but that same ISM gauge for the service sector, which is two-thirds of the economy, is actually very, very strong. That’s a positive.

In addition, if you look at the leading economic index, the US LEI, that’s been hitting new highs. As long as that’s hitting new highs and not turning downward, it indicates that we’re not going into a recession. That particular index has peaked and turned downward four months or more before every recession since 1960. And if you look at it since 1980, the lead time has been nine months.

So I think right now we’re probably looking at an economic expansion that will at least go through mid-year, possibly through the end of the year. You don’t try to second guess the end of these things. You watch for those warning flags.

Right. And historically, what is the average between recessions, or is there such a thing?

There is. The average economic expansion is just about three and a half years. That is from the end of one recession to the start of the next recession.

Now, recessions tend to be relatively short. They tend to be in most cases about a year, but they can be very variable. This last recession we were in was the longest recession since the 1930s, so you can have a bad one if all the bad economic blocks drop into place, like the meltdown in the financial sector in 2008.

But right now, I don’t think even if we were to go into a recession, chances are it’s not going to be a bigger bear market in stocks, because we don’t have the overvaluation that we did in either 2007 or 2000, at the last two bull-market peaks.

Yeah, because the P/E is still pretty reasonable for the market.

The P/E is actually a little bit below the 60-year average. The 60-year average P/E ratio for the S&P 500 index is 17.8. Today we’re at 17.4, and that compares to peaks in 2007 and 2000 of over 23 and over 30.

So realistically, stocks are attractively valued today. And if you look at the fact that short-term interest rates are under 3%, stocks could be called extremely undervalued, probably 20% or more.

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