The InvestMentor

March 5, 2003

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There I said it. I felt I had to, because the people who are supposed to haven't.

The National Bureau of Economic Research (NBER), the so-called arbiter of economic cycles, have to date failed to declare the Recession of 2001 D.O.A. despite overwhelming evidence that suggests the Recession went flat-line almost a year and a half ago.

The problem is that absent a proclamation, economic stagnation becomes self-fulfilling, because consumers are marginally influenced by what they read and hear. The public needs an arbiter, and it would be nice to have one that could arrive at consensus quicker. This is playing an important role in why the market can't maintain momentum.

The NBER is a non-profit economic research wonk tank. They're notoriously judicious (read: slow) in identifying economic peaks and troughs after the fact. They don't hide it either. From their website, we see that they've taken anywhere from five to 22 months to "call" previous peaks and troughs.

I certainly don't fault them for waiting five or six months after a turning point, but 22? They didn't declare the last Recession to be over until almost two years after the fact. Where's the value in that?

While the current expansion has evolved in fits and starts, we're now in our sixth quarter of expanding Gross Domestic Product (GDP). Consider the annualized change in GDP over the last two years.

GDP is certainly not the only measure of economic vitality. But it is the aggregate one. And what it says is that we're rising out of the trough. This is increasingly reflected in the anecdotal evidence of companies' earnings reports, for those that have been keeping track.

In the long run, corporate profits drive stock prices. A massive disconnect between stocks and profits began in 1997. From 1997 to 2000, stocks grossly overestimated profits. From 2000 to 2003, prices overcorrected downward in just as dramatic a fashion. But the market has now adequately compensated for its earlier excesses--and then some. It's literally wiped out the market's growth going back to the start of 1997.

But the economy has expanded by 20% since 1996 and is expanding now. The market will reconnect with the corporate profit picture...if we can just shake that Fourth Plague.

The market's been plagued by four events that have prolonged the decline way beyond the historically typical time frame for Bear Markets of between 12 and 18 months.

The First Plague was the Dot-Bomb--the evaporation of easy money for profitless high tech companies and the massive spillover into corporate investment spending.

The Second Plague was Terrorism--starting with 9/11 and then carrying into the Anthrax scare.

The Third Plague was the Crisis of Confidence--thanks to Enron, WorldCom, and other greedy types found when turning over rocks.

And the Fourth Plague is Iraq.

Once Iraq plays itself out, and it almost doesn't matter how, the market will revert to its normal relationship with earnings unless something else of the magnitude of the Four Plagues comes up. And while it's possible that we'd have a Fifth Plague, it's very unlikely when you consider the historical rarity of the Four Plagues based on their profound impact on the market.

It's imperative to have stock money invested in stocks. As I said last week, when it comes to capturing the early phase of the new Bull market, it's better to be way too early than a little too late. The economic expansion is the catalyst for the recovering market. To benefit from that relationship, we need to put the Recession into the obituary column, and get through the Fourth Plague.