The Long Road Ahead
March 21, 2012
WSJ Blogs - Voices
For the past few decades we’ve had a recession about every eight years. But for the 100 years prior to the 1980s, recessions were much more frequent — about one every three years. We may be returning to the earlier pattern. I believe there’s a good chance we’re due for another recession in 2012, and it could be a bad one. The average market decline during a recession under normal circumstances is 30%, but this time it could be worse.
Here’s why: Historically, consumers have been the backbone of economic growth in the U.S. Since the end of the recession in 2009, we’ve had an economy that been built on inventory restocking and Federal Reserve intervention. In the meantime, the cost of living has risen and wages have stayed the same. Food and energy alone are eating up 20% of the average American’s income.
This is a perfect recipe for stagflation, which is most likely what we’re going to get in 2012.
The fact that the consumer spending of the average American is on the wane is bad news for corporate profit margins. And given that our current expectations for corporate earnings are still way too high, I fear that the gap between expectations and reality could cause a 15%-20% correction in the coming year as markets readjust to real levels of profitability.
The situation looks even worse when you throw in the following: The US is within $50 billion of reaching its debt ceiling, a presidential election is approaching, the eurozone is facing a major debt crisis, and there seems to be no end to scary headlines with the potential to spook investors.
From an investment standpoint, now is not a good time to chase benchmarks. Instead, we’re looking for safe, income-generating investments for our clients. Now that corporations have cash on their books and nowhere to invest that money, they’ll start handing it out to shareholders.
We’re advising our clients to consider alternatives to stocks, such as cash, real estate and energy. When it comes to real estate, we’re talking about real property — mini storage, multi-family homes and plain old home-ownership — rather than REITS. As for gas and oil, we believe master limited partnerships provide a good means of receiving a steady income stream with limited risk.
Unfortunately, 2012 marks the beginning of what I predict will be a long period of slow economic growth. In the 60s and 70s the average household debt to income ratio was 1:2; today it’s 3:1. That means that for every dollar earned, three dollars are owed. It’s going to take at least five to ten years for consumers to wind down the debt. Moreover, instead of the 8% annual growth we saw in the 80s and 90s, we’re going back to 2% to 4% annual growth until we work off the extreme overvaluation we experienced during that time period.
The bad news is there are no shortcuts to an economic recovery (although there are ways to make it worse); the good news is that if you’re a smart investor there are ways to minimize the downside.