Just about everybody and their brother has an opinion about the potential for a recession. Are we headed for one? Are we in one right now? Former Federal Reserve Chairman Alan Greenspan recently weighed in on the matter in a speech, saying that the U.S. is “clearly on the edge” of a recession, and that the odds for a downturn are “50 percent or better.”
But are we? It's probably better just to remain invested, especially if your investing horizon is years rather than months. Remember: Investors often predict poorly, and overreact even when they get it right. Yes, it's true that, in a recession, some companies post disappointing earnings, even losses. That can affect the value of the stock, but not as much as investors might think. Bad earnings in any one year do not have a huge effect on a company's intrinsic value, says Craig Callahan, founder of mutual fund company ICON Advisers.
Remember August 1998? In that year the case for a recession was very compelling, so convincing in fact that the market dropped 20 percent through mid-October. But no recession ever materialized. (It helped that the Fed eased rates.) In mid-2006 the market again dipped as many investors began to believe a recession was in the offing; but their prediction was wrong once again.
The important takeaway is that even if there is a recession in 2008, even if we are in one right now, you don't want to overestimate its potential financial impact. In January, the credit crunch seemed to be spreading to other fixed-income markets, retail sales were weak (but then they got better) and, in general, investors were bailing out of stocks. Opportunity abounds, since these potential-recession dips can take prices far below intrinsic value, setting the stage for rallies, says Callahan. In fact, U.S. stock prices on average are about 36 percent below his estimate of intrinsic value.
Remember, the market's historical tendency is to lead the economy by 6 to 9 months at major turning points. Usually, news is good at market peaks and bad at market bottoms. We may be seeing a classic market bottom right now.