Investor's Guide: The R Word

Not As Big As The U Word

January 22, 2008 - The R word is picking up steam like the wave does at a football game. It stands for recession. The old joke goes that a recession is when your neighbors lose their jobs. A depression is when you lose yours. That's not too bad a gauge, but it doesn't help much. Neither do the official definitions.

A better, more usable definition is supplied by the Business Cycle Dating Committee at the National Bureau of Economic Research. The committee measures the amount of business activity in the economy by looking at, among many things, employment, industrial production, real income and wholesale-retail sales. A recession to them is when business activity has reached its peak and starts to fall until the time when business activity bottoms out and starts to rise again. It sure feels like we're in a recession, according to this definition.

But recession isn't the big, scary monster frightening investors. Rather, it's the U word: uncertainty. Investors can deal with a recession since it's part of the business cycle. Even though it can't be pinpointed as to when it starts or ends, a recession runs its course, flushing out excesses in the economy until businesses feel confident again to expand. Investors understand this and begin to put money back into stocks when they see evidence of better business activity.

What investors can't stand, won't abide, and won't touch is uncertainty. When they're uncertain as to what is going on or what might happen, the natural, self preserving instinct is to withdraw from the uncertainty (take money out of stocks) and wait until a clearer picture emerges. Right now what's clouding investors' vision is the uncertainty of the financial sector. And their vision is so muddied they can't see anything else.

Investors can't put a number on how big the mortgage losses will be. No one can even give a good estimate. On top of that, credit card losses are starting to appear. How big will they be? No one knows. That only adds to the uncertainty. The more uncertainty there is, the more entrenched investors get on the side lines.

A recession is happening now or will shortly. How long it lasts no one knows, but it will end. The economy will expand again. Investors are certain of that. But not until banks start reporting no losses from mortgages or credit card lending will there be a certainty for investors that give them the confidence to fully invest in the bank sector or more broadly, the stock market.

Ted Allrich