Beware the dreaded R word
You don't know whether we're in a recession until months after it starts. But investing successfully requires looking forward, not backward.
(Fortune Magazine) -- Everyone and his brother seems to be talking about recession these days. It dominates every public investment discussion and is the topic 24/7 on cable TV. But let me tell you a little secret: When it comes to investing, the question of whether we're in a recession (or are heading for one) just doesn't matter.
How in the name of Alan Greenspan, Ben Bernanke and all the other economic saints and seers can I be so dismissive of something that's attracting so much attention? Because while the economy obviously matters a lot, both politically and economically, the "R" word is irrelevant to people who want to know how to place their bets on the markets.
Gather around the campfire, folks, and I'll tell you why.
It's actually elementary. Investing successfully is about looking ahead, while determining whether we're in a recession involves looking behind. Way behind. We won't know that a recession has started until months after it's begun. And by that time, things in the economy may well be getting better rather than worse - which might make it a good time to invest.
Now, exactly what is a recession? Opinions vary. Many people think that a recession is defined as two consecutive quarters in which "real" gross domestic product - GDP adjusted for inflation - declines. If you accept that definition, which I don't, you don't find out that a recession is underway until six months - two calendar quarters - after it has started. (Sorry, too late!) If you use what I consider the proper definition - a declaration by the National Bureau of Economic Research's business cycle dating committee that the economy has peaked - you may have to wait even longer. Nevertheless, I prefer the NBER version because it's the collective opinion of seven savvy people rather than a rote formula.
"We wait long enough so that the existence of a recession is not at all in doubt," Bob Hall, a Stanford business professor who chairs the cycle dating committee, told me in an e-mail. "We concentrate on finding the date of the peak in activity, usually at a time the press [has] lost interest in the question of whether we are in a downturn." Typically, Hall wrote, the committee makes its call six to 18 months after the downturn started - or economic activity peaked, depending on your point of view.
I won't bore you with all the grubby details, which you can find for yourself on nber.org. One thing that will leap out at you is the contrast between economic reality and what many people believe. For example, conventional wisdom is that the devastation wrought on Sept. 11, 2001, sent the U.S. economy into a tailspin. The reality, according to NBER, is that the economy was already in a recession, which had started in March 2001 (or, some committee members now feel, even earlier) and ended in November - two months after 9/11. The committee, however, didn't announce this until July 17, 2003. By then, the popular assumptions about the effects of 9/11 were set in stone.
I'm not naive, and I know that the question of whether there's a recession has enormous political implications for the 2008 elections, which is a major reason so many of my colleagues in the media are obsessed with it. But we're talking about investments here, not politics.
I have no idea if we're in a recession or heading for one. Nor do I know where the market is going over the next few months. If I did, would I tell you for $4.99 ($5.99 Canadian)? What I do know is that if you want to do well in the market, you've got to think ahead, not behind. The "R" word isn't helpful. What you need is the "F" word: foresight.