Don't just do something ... sit there

By Don Kuehn

There are some financial writers who seem to have made a career out of predicting the next great American recession. You have probably heard that word tossed about in the news lately by some highly regarded sources who believe we are: (1) headed into a recession, (2) are already in a recession or (3) can't avoid one now.

Well, there's a lot of room to wiggle when talking about an economic phenomenon that can only be recognized through the rearview mirror of time.

You see, the common definition of a recession is two or more consecutive quarters of contraction in the gross domestic product (GDP) or, to put it simply, a shrinking economy over an extended period.

This definition is unpopular with most economists for two main reasons.

First, it ignores any changes in the unemployment rate or in consumer confidence. Second, by using quarterly data, this definition makes it difficult to pinpoint when a recession begins or ends. We can usually only tell if the economy has contracted after the fact, when all sectors that make up our complex system have reported their results of the period just past. As of today we haven't had even one quarter of GDP decline in the current cycle.

Officially, the National Bureau of Economic Research's Business Cycle Dating Committee (BCDC) maintains that "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."

A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough, according to the BCDC. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief, and they have been rare in recent decades.

Whether we are technically in a recession may not be known until the start of the next school year. But if you think it's a recession, based on your economic circumstances, that's good enough for me.

Either way, as of this writing (mid-January) many people are predicting economic catastrophe; with the exception of a serious decline in the stock markets-now more than 15 percent from the October highs-this is not a time for knee-jerk action.

You know the old saying, "Even a broken clock is right twice a day"? Well, those who are in the business of predicting, or who benefit from, downturns in the economy got lucky this time. Parts of the economy are indeed headed down. We may even see "bear market" levels (declines of 20 percent or more) before we're done. But, a general recession? I don't think so as of now.

Don't get me wrong, there's plenty to be concerned about.

• We're at war.
• Consumer spending is weak, and it's the consumer who drives our economy- making up about 70 percent of all economic activity.
• Housing is in the tank in many parts of the country, and credit is hard to get. That means people who were accustomed to living beyond their paychecks are not able to borrow against the equity in their homes or secure cheap loans to finance their lifestyles.
• Oil has traded (briefly) above $100 a barrel.
• Corporate earnings reports for the last quarter of 2007 have been weak to awful, and that could trigger layoffs and corporate resizing.
• Big money banks have had to sell assets to foreign entities to cover bad loans in the collateralized mortgage market.

So, pick your reason for a bleak outlook. Be a pessimist if you choose. But don't panic.
While the forecasters are teetering between recession and slower growth, the current political winds are blowing in favor of an economic stimulus package that would infuse the economy with billions of dollars in immediate cash rebates to families and individuals. (Remember 2001?)

With Democrats and Republicans both trumpeting the need for such a plan (estimates range from $300 to $800 per person) by the time you read this the question may well be: What should you do with your refund to goose the economy? Pay off debt? Buy stuff? Invest? There's no one right answer.

At the same time, the Federal Reserve is chopping interest rates as a move to mitigate as much of the downward pressure as possible on the markets. That, in itself, may not be enough to keep the economy out of recession, but it sure helps companies that need a constant flow of borrowed capital to operate-and it helps ease the pressure on the stock markets around the world.

It's hard to turn a deaf ear to the din of commentators who think the worst is just around the corner. And if we're lucky, it is!

Before the economy can recover from this not-unexpected drop, it must reach a bottom; experts call it "capitulation." Today the markets are down more than 15 percent. If you hold stocks or mutual funds, the temptation might be to sell before you get wiped out. But just because stocks have fallen doesn't mean they will keep falling, unless whatever made them fall is still lurking, or something else happens to make them fall more.

But eternal optimists can make a case that what we have here is nothing more than panic selling. Some people see a corporate earnings report or a decline in industrial production that scares them, so they sell. Stocks go down. News that a local plant is cutting jobs causes someone else to bail out as a defensive move. Stocks go down a bit more. Some people see that others have sold, so they sell. Stocks go down even more. The next guy sees what just happened and he sells because he doesn't want to be the last one out of the room. This keeps going until all the people who act on emotion have sold everything they can and a "bottom" is created. Capitulation.

If your mother didn't tell you this, I will: The idea is to buy low and sell high-not the other way around. It isn't always easy, but that's how people get rich.

Don't get caught up in "paper (unrealized) losses" that look scary but are in line with what the overall markets are doing. If you have a weak stomach, this is not a good time to be checking the progress of your portfolio or paying a lot of attention to CNBC or Bloomberg market reports.

Recession or not, the bottom that is coming will create a classic buying opportunity in stocks and the mutual funds that own them (a chance to buy low) and will form the launch pad for the next big run-up in stocks.

After the markets recover, you'll want to be sure that your investments are properly diversified and that your assets are allocated to minimize the effect of the next downturn in the economy. That means splitting your money between stocks, bonds and cash instruments, like money market funds.

It means allocating the stock portion of your portfolio in a mix of large-, mid- and small-capitalization holdings (if you have followed my columns in the past, you know that I favor no-load, low-cost mutual funds over individual stocks for most investors). Some may be "growth" funds and others "value" funds. You may spread them around in core accounts like an S&P 500 or "total market" fund, international stock, energy or other sector funds.
The old bromide of not putting all your eggs in one basket is especially true in investing. Diversification cushions against one sector's poor performance by spreading your assets around in investments that react differently to the same news. It's critical to avoid the next "big one."

But rejiggering your portfolio is for later, when you can sell some of your holdings when prices are high (remember, sell high?). Markets run in cycles. They ebb and flow, expand and contract, go up and go down. To expect otherwise is silly. You just want to capitalize on the markets' gyrations by protecting against big dips and taking advantage of buying opportunities when they appear.

Let me say, I could be wrong on this. But if we do experience a recession, not just a correction in the markets, it won't be the first, or the last one we will see. If you have cash sitting on the sidelines, this is a great time to buy; otherwise, resist the temptation to join the bottom-feeding panic sellers. Don't just do something. Sit there.

It's your money.