Personal Finance—‘Shilling’s List’ May Have Recession-Proofing Advice

The newspaper said he was dead, but Mark Twain responded with immortal words: “The reports of my death are greatly exaggerated.” Can the same be said of economic recessions? The question is accentuated by December’s blood-curdling decline in stock prices. For the first time, many participants in 401(k) plans have seen a decline wipe out a full year of contributions. For those with company stock in their 401(k) plans, the decline can be even larger. Worse, major losses aren’t limited to New Economy dot-coms, technology darlings or telecom wunderkinder. To see real employee pain, you need only check the collapse of J.C. Penney stock, a major holding in the retailer’s 401(k) plan. The conventional wisdom, fully anointed by Wall Street, is that we are in a slowdown. Instead of growing at an unsustainable rate, it says, we’ll have a few quarters of slow growth. It will be just enough to keep the riff-raff from building too many 10-000-square-foot log cabins in Jackson Hole, Wyo. Wall Street views Alan Greenspan, chairman of the Federal Reserve, as a kind of Army doctor. He can fix all maladies with interest rate-cutting aspirin. The aspirin cure is on the way. When I see such comfort, I feel a need to check the less conventional sources. One of the more carefully laid-out arguments pointing to recession comes from economist A. Gary Shilling. Long a deflationist some would accuse him of being a dour Johnny One-Note Mr. Shilling pays attention to things glossed over by those paid to be optimistic. Here are some of the factors call it Shilling’s List that he believes will drive us into recession: Wealth recession. Consumer spending tends to rise with consumer wealth, aiding spending. Now it is running in reverse. More important, some were hit harder than others. Those who borrowed to buy stocks, for instance, have seen their assets plummet while their debt remained the same. Significantly, margin debt has soared in recent years, reaching 3.5 percent of personal income last autumn. As Dallas bear David Tice likes to say, “Debt is forever.” Savings shift. A continued decline in stock market wealth could bring an even broader shift in our economic behavior. Some households will compensate for recent losses by increasing their saving, aggravating any recession. Energy-driven purchasing power losses. Noting that energy costs have a delayed impact on spending habits, Mr. Shilling believes that we probably haven’t seen the major impacts on retail spending yet. When heating your house and driving to work cost more, there is less money to spend at the mall. Consumer borrowing retrenchment. Consumer borrowing has topped out. Consumer credit has slowed and the response rate to credit card solicitations has plummeted. Personal bankruptcies are rising. An auto industry slowdown. Still a major driver in the consumer economy, dealer stocks of SUVs and pickup trucks rose from 58 to 71 days in November. With discounts and deals on new cars at record levels, used car prices are weakening. Worse, since SUVs and pickup trucks account for 120 percent of auto industry profits, a slowdown is likely to bring aggressive plant closings. Lack of government spending stimulus. Operating at a surplus, the government is taking consumer spending out of the economy. That’s the reverse of everything we have experienced since World War II. There is more, but you get the idea. Signs of recession abound. Does this mean we should sell our stocks and mutual funds? No. Market downturns come months before actual economic downturns, not after. Many stocks are now selling at normal valuation levels. While the greatest buying opportunities have been in periods of depressed valuation levels, a market at normal valuation levels is a good sign. This year we won’t be overpaying for new stock purchases. Today’s Price, Last Year’s Value Question: A quick look at Yahoo charts today revealed the following: (a) same level as one year ago: GE, Cisco; (b) same level as two years ago: IBM, Microsoft, Hewlett-Packard; (c) same as five years ago: Apple, Motorola; (d) one-half what it was five years ago: AT & T.; Is “buy and hold” dead? , J.G., by e-mail Answer: The fact that some stocks are below the price level of a year or two years ago does not mean that “buy and hold” is dead. Similarly, your calculation of the value of AT & T; may have omitted the value of Lucent, spun off in early 1996. If anything, your figures confirm the wisdom of buy and hold as a long-term investment strategy. You can understand why by examining the basic statistics about stock performance. While the long-term return on all large common stocks, as a group, is about 11 percent, their annual standard deviation in price change is nearly twice that amount. In other words, there is a 66 percent chance that your portfolio return will be somewhere between minus 9 percent and plus 31 percent. The other third of the time, your return will be worse than minus 9 percent or better than plus 31 percent. This means you can do significantly better than 11 percent in any given year or significantly worse. If we are to be long-term stock investors, we need to live with the idea that we may see our portfolio fall back as much as two years in value. The price volatility of individual stocks is even greater. Over the last three years, for instance, the annual standard deviation of a typical large stock has been 57.2 percent, and its average annualized return has been 13.8 percent. This means that two-thirds of the time your return on an individual stock in the last three years was likely to be 13.8 percent plus or minus 57.2 percent. So it shouldn’t be very surprising that some stocks are selling where they were selling two, three or even four years ago. There are, of course, many people who will urge us to take advantage of those price swings to buy at the bottom and sell at the top. The only problem is that neither the bottom nor the top is clearly marked. To me, these realities are powerful arguments for indexing your investments. While it is difficult to know which stocks will be the best performers in any market, it is very clear that more companies are creating value than are destroying it. So indexing puts you on the winning side. Questions about personal finance and investments may be sent to Scott Burns, The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; or by fax: (214) 977-8776; or by e-mail: scott(at)scottburns.com. Check the Web site: www.scottburns.com. Questions of general interest will be answered in future columns.