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09/03/2009
Double Dip?
By
David B. Kantor
The last time I wrote you, it was back in late March. It was a particularly bleak time, with the market having recently touched a ten-year low of about 6,500 on the Dow. Five months later, I don’t think anyone would dispute that things are looking considerably better. The U.S. banking system is no longer on the verge of collapse. The rate of economic decline has slowed markedly and the recession is widely expected to end in the next few months. And perhaps most positive for the psyche of investors, the stock market has risen sharply…up nearly 50% from its March lows.
There is still a lot of uncertainty out there, but it is a positive sign that we are now wondering what kind of recovery we will have, rather than - as before - wondering whether we would have a recovery at all or whether the whole system would collapse. The form that the recovery will take will have a significant effect on stock prices over the next couple of years.
Usually after deep recessions, the recovery is large and rapid, measured in both economic activity and stock market prices, as businesses adjust quickly after making deep cuts during the downturn. So judging by history, this would be the likely course of events.
The pessimists fear a “double dip” recession where the young recovery is choked off by the need for the government to reduce deficits by cutting spending and raising taxes…the negative effects of these two measures being likely to slow the economy so much that it slips back into recession mode. Double dips are great at the ice cream store, but not so attractive in economies.
A middle, and increasingly likely, scenario allows for a shift of consumers’ attitudes toward more savings and less consumption (which would, in the long run, be a good thing)…if this happens, then the economy may exhibit much more modest growth than in a typical recovery. In that event, given the rapid recent run-up in stock prices, there may be some short-term earnings disappointments and a pullback of some of the recent gains.
At PMA’s last investment committee meeting, we decided to maintain our target equity-bond mix at slightly below long-term averages, since there continues to be considerable uncertainty about the intermediate-term outlook. We are focusing our equity investments on managers picking quality companies with steady earnings and little financing risk. We also shifted more of our bond investments into high-grade corporate issues of short and intermediate maturities. By doing so, we can pick up additional yield while taking on very little additional risk. Those are the judgments that we make at PMA, not guesses about where the stock market might be headed over the next six months.
Of course any investment decision involves some uncertainty, but as always at PMA, we continue our policy of carefully evaluating and judiciously assessing risk, and favoring those investments where the risk/reward tradeoff is most attractive. These policies and our collective experience have helped us, and our clients, to weather this tumultuous period.
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