Recessions and opportunities

By David Vomund
Special to the Bonanza
May 9, 2008

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There is a debate in the financial media about whether the economy is in a recession or a depression? By its textbook definition, the answer is neither.

For the rest of the world, the textbook definition occurs when real GDP (gross domestic product) declines for two consecutive quarters.

Not here.

The National Bureau for Economic Research (NBER), a private organization, determines when a recession occurs.

To them a recession must show several months of declines in four areas: real personal income, non-farm payrolls, inflation-adjusted sales and industrial production.

In 2001, there was only one quarter in which real GDP declined, yet the NBER still called it a recession.

With our first quarter’s GDP a positive 0.6 percent, it's now very likely that we won’t see even one negative quarter before growth picks up later in the year.

By the textbook definition, this is not a recession. Still, the NBER may very well call it a recession. No matter.

A slowdown by any name is a slowdown.

Recessions happen (11 since WWII), and we sure haven’t seen the last one. They typically last two or three quarters, then they recover and expand. It has always worked that way. It always will.

That’s not to trivialize today's problems. I won’t try to put a kind face on them. The excessive use of leverage around the world by banks, Wall Street firms and many others (real estate speculators, hedge funds) is being reversed.

While it took a decade for leverage to reach the most excessive levels, it’s taking only months to undo much of it. The more aggressive will stumble, and there have already been casualties among hedge funds, Bear Stearns and scores of mortgage companies. Others have taken large write-downs. There will be more pain ahead.

With all that said, I’m very optimistic for the economy and the equity markets.
Since the early 1980s, there have been several times in which events were every bit as worrisome (or more so) as the credit crunch and mortgage mess is today. For example:
In the early 1980s, Paul Volcker's Federal Reserve raised interest rates well into double digits. The prime rate topped out near 20 percent. Mortgage rates were in the mid-teens.

A few years later the eighth-largest bank (Continental Illinois) folded.

Then came the 1987 crash and soon after that the savings and loan debacle, which was far more significant in a much smaller economy than today's sub-prime losses. In the 1990s there were government bond defaults in Russia and Argentina, and economic crises around the globe, most notably in Mexico and southeast Asia.

As the decade ended, a hedge fund few had heard of (Long Term Capital Management) was so leveraged to the wrong side of the bond market that the Fed had to come to the rescue to prevent a financial panic and meltdown. Then came 9/11.
As each crisis unfolded, many investors dumped their stocks.

They panicked. But smart investors were buying, not selling. And clearly history shows that one should have been buying stocks when the headlines were terrible.
Investors should ignore the short-term gyrations and use exchange-traded funds (ETFs) to own the leading market segments. There are always uncertainties, without which there would be no opportunities.
There are opportunities right now.
David Vomund is president of Vomund Investment Management, an Incline-based firm that specializes in growth using exchange-traded funds. His Web site is www.ETFportfolios.net