Why It's Time to Be Invested in the New Recession

Let's try to straighten out a few things. Are we in a recession, or aren't we in a recession? Could Google (GOOG), IBM (IBM), Ebay (EBAY), or Intel (INTC) do what they just did if we are in a recession? I hear commentator after commentator state that the current recession is a fact. In an interview with Tim Russert, CNBC correspondent Maria Bartiromo summed up Wall Street consensus perfectly when she said:

We could be talking ourselves into a recession..because all of the headlines and all of the negativity out there.

To help clarify why sentiment got so bad so fast, it's important to understand two important dynamics.

First, we're dealing with financial sector weakness. When the financial sector feels pain they make sure everyone else does too. The Enron-induced mark-to-market disclosure laws forced our institutions to take unprecedented writedowns as real estate prices corrected. Loan defaults weren't the problem, dropping CDO valuations were. This unintended consequence turned a normal, healthy real estate correction into widespread nightmare. We have dealt with similar corrections before, but this one has been different. On April 10, Fed Chairman Ben Bernanke said:

...mark-to-market accounting has been sometimes destabilizing in that sales of assets into very illiquid markets had led to reductions in prices, which have caused writedowns which have sometimes caused firesales, and you get into an adverse dynamic which has caused problems in some of our markets.

U.S. banks and brokerage firms are not accustomed to volatility. Once the massive writedowns started pouring in, many on Wall Street saw their careers flash before their eyes. Instead of conducting unbiased research and making smart, long-term investment decisions, they worked themselves up into a frenzy with questions like, am I going to have a job tomorrow? Who are we going to merge with? Will my world ever be the same? Their traditional culture of stability had been replaced by a culture of panic. The entire investment world revolves around the decisions made in New York City, but for a few months New York City was reeling. Since they were experiencing a recession, it was assumed everyone else was as well.

This phenomenon turned the entire market into a group of day traders with no memory of yesterday and no thoughts of tomorrow. We fluctuated from data point to data point like a ship getting tossed in rough waters. None of this panic occurred when the auto industry fizzled, and it didn't happen because of bankruptcy threats among the homebuilders either. It only happened because this crisis directly affected our most influential decision makers on Wall Street.

The second reason why panic struck is a simple calendar issue. What happens during the first half of an election year? Voters elect Presidential nominees. What do these nominees talk about in every interview and in every debate? Change. It is their job to paint a negative picture of our economy so they can come in and clean it up. That's exactly what they did. Consumers were bombarded with statements of negativity even though they still had their houses and their jobs. After all, unemployment levels are still near historic highs.

The daily political rhetoric confused Americans and added to the financial crisis. Politicians began to hold hearings, activist hedge funds began spreading rumors that caused unneeded runs on banks at Etrade (ETFC) and Bear Stearns (BSC). Now that these loud voices have quieted down where does that leave us? It leaves us with a major disconnect between perception and reality.

However, we are witnessing the reality during this earnings season. So far the companies who don't have exposure to financials or housing can be bought. This week saw Intel, IBM, Ebay, and Google all report stellar earnings results with positive outlooks on the future. The credit crisis hasn't touched them as we feared it would. The fear expressed so often in the media caused many investors to sit on the sidelines in cash - they must have been sick watching the Dow rise 228 points and Google adding $90 on the same day Citigroup (C) announced another $13-billion in write-downs.

If we are in a recession, it's a new kind of recession. One that is a stock pickers dream if you can pick out the companies unaffected from the turmoil. Just because a few sectors are weak doesn't mean the entire system has to implode. It is time for those companies who have been unjustly punished to rise back up where they belong. Because of the mark-to-market rules I still wouldn't touch financials until we see a turn in real estate prices, or until that law gets changed. Other than that, last week showed us some important trends taking place. It's time to be invested in the new recession.

Disclosure: The author owns GOOG.

Comments

[Adan]

so, can i expect the same line of thought when things are only slightly improved, and sentiment is mostly positive, that then, one should be cautious about an then evident over optimism?

maybe, maybe not; but i like this article for demonstrating that it's investor sentiment that swings the strongest :-)

[globalmacro]

Beautiful Commentary! We have several clients who work on Wall Street and they've worked themselves up in the exact way you describe. I've been saying this since late January but it's been hard to find anyone but outright bears on these boards. Thankfully, I understand that the overwhelming negativity was very bullish. We were very long Google going in to earnings and we've been rewarded for continuing to buy exactly the type of companies you describe. This is one of the best pieces I've read on here this year. Thank you.

[htroute66]

I couldn't agree with you more. With all these ANALysts trying to save their jobs because they have been wrong way more then half the time they are scared as hell! Stifel even has a buy on AMD! AMD has reproted $5 bil in losses the last six qtrs and may not even be able to finance their debt ( according to their OWN reports ). They have NO money in the bank and will probably lose monney for at least two more qtrs! Where in the hell do these ANALysts make this shit up? And you are 100% right about the financials and the bought politicians! Just look at Pelosi.....our #3 in line to the Preidency.... The airhead knows absolutely NOTHING about economics! As a matter of fact....I can't think of ONE Democrat that does......Look @ Billery and Obama! Spend out the ass and RAISE those taxes!

[Jim Hawthorne]

There is no doubt that "Investor Sentiment" is very important... But let's remember that "sentiments" do not just fall out of the sky; they are grounded in perceived conditions, which in turn, are driven by conditions in the real world. Sooner rather than later, perceptions must become aligned with reality.
While it may be possible to talk ourselves into fearful profit-taking or over-optimistic dip-buying, it is ridiculous to say we can "Talk ourselves into a recession". Anyone making such a claim either has no idea what "recession" means or is desperately struggling to raise the tide by sheer force of will.
A note to htroute66; you might wish to display your own grasp of economics with a more reasoned analysis of government spending and fiscal policy over the past 7 years!

[crowdofcheerleaders]

the smart money doesn't care about your sentiments.

[flatman]

I remember a time when sentiment said that a 200 PE or no PE was Ok if a company had a business plan that included the words 'dot com'. That didn't work out so well for a lot of folks. Unfortunately in the real world right now corporate profits are being juiced by a weak dollar at the expense of the consumer who will pay more at the pump and in the grocery store.

[karchad]

not only should you be buying companies unaffected by the turmoil, but it is precisely the time to buy the "turmoil" sectors of financial and homebuilders. if everyone's agin' it, then i'm fer it!

[globalmacro]

after reading karchad's commentary and the use of the words "agin'" and "fer", ive turned completely bearish and i'm now 100% short. this was clearly a sign that the worst isnt over. haha.

[atauber]

if BAC comes out with losses and the stock barley losses anything then this already priced in the money so if after this qurter they start making money the sky is the limit for all these shorters

[A midwestern neighbor]

Mr. Hawthorne, I don't believe htroute66 said that the current admin has done perfectly economically. Yet it remains true that they have gotten a couple things right: a) the tax cuts were *not* just for the wealthy (i'm a middle income guy, and it made a difference for me), though the Dems would have everyone think so; and b) the lowering of the cap gains tax likewise does *not* benefit only the wealthy - 80% of those reporting cap gains in recent years have been middle-income folks.

Meanwhile, Obama's plan is not merely a graduated tax plan, but wealth redistribution...an undermining of the entire capitalist economic system. What both he and Hilary (well, most Dems, really) fail to recognize is that there is no perfect system, but that crippling capitalism by excessive redistribution does *not* minimize the number of poor - it instead increases it due to lost incentive!

So what really ought to happen? We are all overtaxed! And the only way that gets back to where it should be is across-the-board tax cuts. The budget has to be balanced...and frankly, this should not be the issue that is appears to be! We all know that excessive bureaucracy never makes any program cheaper. There are plenty of federal offices and bureaus that do not need to exist (Um...the IRS comes to mind!? How about a simpler tax code and can two-thirds of that bureau? What does the DOE really do? That can't or should not really be done at the state levels...or lower?? Etc. etc. etc.) There is so much waste and so many socialized services and programs that really ought not to be such - I firmly believe that we have reached the point where we are all better off fiscally to cut them and put the dollars back in citizen pockets where the *choice* is back to each of us to spend those dollars where we most need or want to! Hmmm...that sounds strangely like a restoration of freedom! Not to mention fiscally sound.

[Jim Hawthorne]

Neighbor! Hi!
Main point concerns the recession issue.
I hold no strong brief for either party's platform in the upcoming November derby... We trade and prosper in spite of the politicians... not because of them! Tax plans come and go, and can be changed at the drop of a hat, as we well know.
In my opinion (and that's all it is), the pickle we are in at the moment has a lot to do with several decades of fiscal irresponsibility of one form or another.
We're where we are because of low rates, easy credit and a huge oversupply of $$$... (see the M3 estimates which the Fed in its wisdom no longer publishes).
There is lots of blame to go around, and while the roots lie back in the late 80's/90's, the current administration has exhibited a retreat from traditional Republican fiscal responsibility; a tradition I strongly support.
Thanks to the tax cuts we might just be making a few more dollars, but at the rate we're going, it will take a wheelbarrow-load of them to buy a coffee and a danish anywhere outside of the US! In real terms, are we better off now that we were in the 1980's???
Anyway, what was it that pundit said back in the 60's... "All governments are run by crooks and liars, and you should never believe a word they say"... or words to that effect.

[portconnor]

i am a 38 year old with a decent investment portfolio. i have watched several generations of my family work a regular job and retire with huge returns as the market bounced up and down in and out of small recessions. i will not stop throwning my money into the market especially now if anytime in my life i had a dollar. i think a few of us will be standing at the finish line saying i told you so in a few more years while the rest of our peers will be saying "i should have" or "i would have" or "if only". US history has proven that this is the land of opportunity. invest now or regret it later.

[whidbey]

Where do we get such idiots! Congress has spend the future, believe in what you like, but know this: The Medicare Part D will cost 10 Trillion in present value at enactment. Same for the booked national debt, about 10 trillion PV today. You may be at the finish line, but you will not have anything left after your taxes, and other benefits are paid out of your income. It is not the same as when your parents invested. You will do with less, much much less.

[BlueOkie]

We have 5% unemployment, 3% inflation, and 6% 30yr Mortgages. 40% don't pay income taxes; tax rates are low for others. Housing crisis means lower prices for buyers! Low dollar increases balance of trade. Higher gas prices incentivizes alternate fuel sources.

[GregoryY]

Excellent analysis of politically induced recession and an excellent opportunity for above average returns.

[iThinkBig]

Jim Hawthorne is dead on. The fundamentals stink. Perception or mark-to-market accounting scams can only prop up Wall St. so far. Meanwhile, in Main St. people lived beyond means and the liquidity crisis has dried up easy credit. The solution is not socialism which is now being applied. This failed during the Great Depression and it will fail now. All that really is occuring is a contained market collapse and slow motion unwinding of trillions of dollars of counter-party risk (there's your real panic honey!). What needs to occur and is happening despite banker bailout attempts (socialism with besieged taxpayers bearing the brunt) is housing hitting bottom which has not happened and will not for many months. This will erase up to five trillions of fabricated home owner and commercial real estate wealth. In between, we as a country may just want to declare an energy crisis, subsidize $200 B of treasury into alternatives (and I also mean DRILL EVERYWHERE) and create a competing global market for oil meaning new global investment opportunities. This creates millions of jobs, pops the commodities bubble and gives consumers (70% of the GDP) disposable income again. Oh yeah, wouldn't hurt to provide the global consumer more of what they want, abundant energy and cheaper food!

[ngwun]

Will anything we say alter a course of events influenced by those in power who think that the world is "Me & my Mates"?

It just might.

[galewhitaker]

This optimisim is total nonsense. The world has run out of cheap oil and because of that it will never be the same again. The price of oil is headed to $180/barrel. The physical structure of our civilization was built on $30 oil. There are hundreds of milliions of people that will not be able to heat their homes next winter. Currently there are 600,000,000 gasoline powered vehicles on the road. The great majority of these vehicles are now useless. Tell me again how the ecomony is going to blossum and stock prices are going to sky rocket.

[ajhough]

galewhitaker is about correct. We are watching the dollar implode, oil explode, food riots around the world, and are living on borrowed money. We are exporting dollars to the middle east by the bales, have no policy, and are indifferent to the plight of our own people. It is much easier for Iraq's citizens to obtain school, medical, and intrastructure aid that our own states. And...we will probably vote for four more years of the same...

[Arabianinvestor]

We have hardly started to see the financial crisis roll out into the real economy yet - but that is hardly a good reason to think that it is not going to happen! This is all wishful thinking - good companies will survive a shake-out but their share prices will fall along with everybody else...The DJ is far too high for a recession! If you don't get that you should not be investing in stocks.