‘Recession,’ Stocks & the Fed
What to think?


Early Tuesday morning, as global stock markets plummeted on fears of a U.S. economic recession, the U.S. Federal Reserve made an unscheduled adjustment to the key federal funds interest rate, lowering it three-quarters of a point to 3.5 percent. The action, however, was not enough to calm equity markets, with the Dow Jones dropping more than 120 points on the day and closing below 12,000. Markets are volatile. Recession — though not in the data — is certainly in the air. What should investors think? National Review Online’s resident financial experts have some answers.

People who believed in the Bush boom and got into the markets when the president cut tax rates in 2003 have done very well. If you read NRO and have bought into the ideas of Larry Kudlow, Art Laffer, Steve Forbes, Rich Karlgaard, Brian Wesbury, Don Luskin, and yours truly, you made money. If you bought into the leftie doom-and-gloom scenario of Paul Krugman et al, you missed one of the great wealth-creation events in modern history. Bush proved, once again, that Reaganomics isn’t just theory — it really works. It works when Republicans like Calvin Coolidge use it. It works when Democrats like JFK and Bill Clinton use it. It even works when Russia and China use it.

But it doesn’t work when it’s not used, and that’s what’s happening to investors right now.

There’s been a great deal of discussion about whether or not the Bush tax cuts are going to expire at the end of 2010. But almost nobody has mentioned the fact that some of them have already begun to expire. The tax cut of 2003 extended a provision which changed the law (for fellow code-heads like myself, I’m talking about section 179) so that businesses could deduct durable-equipment expenses more quickly than had been allowed previously. Instead of forcing businesses to spread the tax deductions out over five or seven years, they were given greater leeway to deduct the purchases at the time they were made. That provision expired three weeks ago. No wonder investors are apprehensive about a slowing economy.

It’s not just the business-equipment deduction; it’s also the whole cluster of issues that buzz around the presidential election. Every caucus and primary election is a leading indicator of future tax and regulatory policy. Investors are just registering what they see. And they see that since Iowa, the pro-growth party has been in disarray while the anti-growth party has been the beneficiary.

If you don’t believe me, just look at the Intrade political-futures market for a Republican win overlaid with the Dow Jones Industrial Average. As the GOP prospects fall, so do the prospects of the investor class. Either a pro-growth candidate becomes a front-runner, or a front-runner becomes (persuasively) pro-growth. Otherwise investors will remain jittery. Do you blame them?

– Jerry Bowyer is the chief economist of Benchmark Financial Network.

During market downdrafts, investors get the urge to do something. However, this is one of the biggest mistakes they can make. When investors increase their cash exposure during short-run market corrections, they lock in losses and insure that they will not participate in the upside as markets recover. The U.S. experience during the last few financial crises bears this out. Looking back, I can point to Black Monday in 1987, the Mexican peso crisis (1994), the Asian Tigers crisis (1997), and the Russian default crisis (1998) as periods when a market tumble was made back in short order. The investors who held their positions were the ones who came out whole.

From a policy perspective, the current episode suggests that the Fed is ready to provide necessary liquidity while remaining vigilant of the underlying inflation rate. Looking back at prior market turbulence, the Resolution Trust Corp. episode of the early 1990s (an exception to the modern-day rule of quick market recoveries) shows that monetary policy alone may not overcome fiscal-policy mistakes. Recall that President George H.W. Bush raised tax rates around that time, and the economy went into a recession. The proper policy would have been a tax-rate cut. This would have increased after-tax cash flows and asset values, both of which would have accelerated the economic and financial recovery.

– Victor Canto, Ph.D., is the founder of La Jolla Economics, a research and consulting firm in La Jolla, California. He is the author, most recently, of Cocktail Economics.

Stock market corrections and economic recessions come and go. It’s the nature of a free economy. Add to that Schumpeterian gales of creative destruction, as technological advances bring down old industries in favor of new ones. Turbulence is part of capitalism. But Tuesday’s turbulence should not dissuade investors from buying stocks for the long-run.

This strategy essentially argues for investing in America, which has produced the greatest prosperity in the history of history. I do not see this changing. Right now the stock markets have corrected by roughly 20 percent — the first time in about five years that we’ve had a true correction. To me this means there are a lot of bargains out there. In fact, the market averages at these levels represent good bargain prices.

I always recommend buying broad stock market indexes. For example, the Dow Jones Wilshire 5000 or the S&P 500. Owning international indexes also makes sense, including emerging-market indexes. A package like this gives investors good diversification, keeps it simple, and covers the world.

I don’t foresee the overthrow of free-market capitalism, and not even Senator Clinton will bring back state-run socialism. Folks who bought the market in late 1987 and held it for twenty years did extremely well. I don’t recommend timing the cycles, and certainly not trading on a daily or short-term basis. The idea is to stay long-term. Younger investors should be 100 percent in stocks. Middle-aged investors should be about 80 percent in stocks. And elderly investors should probably be about 50/50 between stocks and bonds.

Be invested. Be diversified. Use cheap exchange-traded fund indexes. And stay optimistic.

– Larry Kudlow, NRO’s economics editor, is host of CNBC’s Kudlow & Company and author of the daily web blog, Kudlow’s Money Politic$.

Donald L. Luskin
Should we panic? The answer to that question is always “no” — in investing as in life, panic just keeps you from making smart decisions. In markets, panic offers unique opportunities for those who can keep their heads while those around them are losing theirs. And that’s just what those around us are doing. The so-called crisis in subprime mortgages is actually a very small economic problem in the scheme of things — equivalent in its dollar impact to the cost of reconstructing after Hurricane Katrina. Expensive and regrettable, and a tragedy for those directly involved, but really nothing in the context of our massive economy. The scare on Wall Street about exotic debt instruments related to subprime mortgages is just that — a scare on Wall Street. Some big firms and some big players are going to take some big losses, but that’s why (usually) they make the big bucks. None of this ought to throw the U.S. into a recession. All the fear that’s abroad in the land may result in a brief slowdown, but actual recessions only occur when interest rates get so high as to crush economic activity. In this business cycle they’ve never gotten high, and right now they’re headed lower. So don’t panic. This is an opportunity!

 – Donald L. Luskin is chief investment officer at Trend Macrolytics LLC.