Economy

BULLS & BEARS: With or without recession, next few years look good

January 9, 2006

In recent days, the yield curve inverted as the 10-year Treasury note yield dropped below the two-year Treasury yield by 100th of 1 percent. This miniscule inversion caused a freakout on Wall Street and sent stocks into a swoon.

Here's why:

The Fed has tightened rates eight times in the last three decades, according to Merrill Lynch economist David Rosenberg, and five times it resulted in an inverted yield curve. Within one year of each of those five inversions, the economy slumped into a recession.

The consistency of the inversion-equals-recession made investors nervous.

During the recessions, the stock market has endured a pretty good whacking (the technical term for a 10-percent to 20-percent drop in the market) as economic news has grown worse.

Still, recent recessions have not lasted long and have about ended just when the popular press is convinced we are in one. And the stock market recovers from the whacking long before the news improves.

The only two recessions where stocks continued their fall were the ones where big shocks-Watergate and 9/11-happened months after the start of the economic slowdown and exacerbated the market decline.

Today's market has been generally in an uptrend since the Dow bottomed at 7,500 in 2002.

Previous recessions that started while stocks were in a general uptrend resulted in markets that reacted like your car going over a large chuckhole: noisy, tough on the spine, but not disastrous. And in each of those instances, stock prices were a lot higher three years down the road.

Another good thing going for us is that this is a midterm election year.

It is not the political mudslinging I'm looking forward to, but instead how the market tends to perform. We all know the political party in power will do whatever it takes to keep control goosing the economy to make voters fat and happy.

In the two-year spans between the market's low of the midterm year and the peak in the general election year, stocks have had a huge move up.

This big move has happened like clockwork since 1950 with the average gain registering 55 percent. The most anemic was the gain from 1986 to 1988 at only 40 percent, and the mother of all runs was 1970 to 1972 at more than 200 percent.

So let's take the worst case and say a recession is looming and the Dow drops 15 percent to the low 9,000s this year. Let's also say the subsequent recovery only matches the worst previous at 40 percent.

Those two assumptions would put the Dow at 13,000 in 2008. If the market stays above 10,000 for a low in 2006 and matches the average recovery, the Dow would go to 15,500 by 2008. Recession or not, ignore the noise of the coming political fracas and enjoy the two-year run.



David Sheaff Gilreath is co-owner of Sheaff Brock Investment Advisors, LLC, a money management firm specializing in separate account management throughout the Midwest. Views expressed are his own. He can be reached at 317.705.5700 or daveg@sheaffbrock.com.
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