Dear Mr. Market:

It’s been well documented that you have a pretty volatile personality. There are days when you tempt us with optimistic stories and the potential to make tons of money in a roaring market. Suddenly, you turn on us and show investors your angry and pessimistic side with sharp drops in the stock market and ultimately their account balances.  It’s almost as though you have a split personality and we actually think that the same case can be made about our economy; the United States basically has a “split economy”.

We apparently have officially climbed out of a recession but if you ask most people on Main Street if that’s the case you’ll likely find that’s not their view. Even big businesses are still hoarding cash in what feels like nobody trusts tomorrow or what is around the corner.

Is this recession really over?

The word recession itself conjures up negative emotions and is the topic of many heavy conversations. This past recession was impactful enough to have even earned itself its very own name. It’s been called the “Great Recession” and some have even called it the Lesser Depression, the Long Recession, or the “global recession of 2009”. While so fresh on our minds, let’s first ask ourselves why that is and also assess where we’re at now relative to it.  Secondly, let’s ask when the next recession is coming?

Investopedia defines a recession as a “significant decline in activity across the economy, lasting longer than a few months”. What technically counts as a recession though is when an economy has two consecutive quarters of negative economic growth as measured by GDP (gross domestic product). Recessions typically last anywhere from six to 18 months and contrary to popular opinion or knowledge…they’re actually part of the normal business cycle and much more common that you might expect.

The “Great Recession” officially started in December of 2007 and ended in June of 2009. Economists tell us that we’re out of the recession and if you were to just look at the numbers one could actually paint a deceptively pretty picture. We’ll leave that up to politicians to do but just by the numbers we’re actually at all-time highs…and we’re not talking about the stock market but rather the actual economy. What!?!

Say that again!! Yes…the United States is the richest it has ever been.  Per the Bureau of Economic Analysis, our GDP per capita (how much the economy produces per person) just hit an all-time in the second quarter of 2013.  Why doesn’t it “feel” like it’s over then?

Part of the answer goes back to our split economy that we’ve actually always had but it’s now perhaps more so than ever before. The average net worth for the upper 10% of households has increased over the past 10 years. Conversely, the remaining 90% of the population has seen their net worth decrease. The same divergence can be seen with income growth from the top and bottom of our nation’s households.  In many aspects the Great Recession has amplified and widened this gap. This reality is also why it’s important to distinguish a great stock market from a great economy.

Much of this divergence is due to the rebound in the stock and housing markets. Over the first two years of the economic recovery the wealthiest 7% of the nation saw their net worth increase by 28% while the remaining 93% of the population’s net worth declined -4%. (Source: Pew Research Center) The old adage of “as the tide rises so do all the boats” is sort of a paradox in this situation. To state the obvious if housing and stock markets double but you don’t have a position in either you simply won’t benefit from these numbers.

We would argue that the recession is not over. It is by technical definitions but by how we must gauge it…it’s not. Additionally, economists are historically notorious for being almost useless when it comes to forecasting recessions. According to Variant Perception 9 out of 10 economists have failed to forecast the last several recessions due to: (1) focusing on the lagging indicators, such as employment data, and (2) focusing on incomplete data or basically numbers that will almost always be revised anyway in three to 12 months! Nobel-laureate Paul Samuelson famously said it best, “Economists have successfully predicted nine of the last five recessions.”

Knowing that there have been 47 recessions since 1790 won’t help you be a better investor. What is helpful is being aware that recessions are fairly common and also understanding that they are shorter and less severe since World War II.  Since 1960 the U.S. has had eight recessions and we typically average one or two each decade.

Wikipedia states that “ The average duration of the 11 recessions between 1945 and 2001 is 10 months, compared to 18 months for recessions between 1919 and 1945, and 22 months for recessions from 1854 to 1919”.

Back to our premise of split personalities… we’re seeing this to some degree with consumers gaining some confidence but corporations still wanting to hold back a bit. This divide basically has to do with what is real versus what is imagine in our economy.  We won’t begin discussing doom and gloom statistics because the media already does its fair share of letting us know most of it. There are some things to be optimistic about but if there was ever a time to be cautious about certain parts of this market it’s now.

We see a stock market that has run far ahead of the economy and that can really sucker people into not understanding what our reality is.  Much of this market has been obviously propped up by the Fed and quantitative easing. If you’ve paid any attention as of late the slightest talk of going the other direction (“taper” talk) is sending fear throughout markets across the globe.  The critical thing most investors are not trained to see is that the economy and the stock market have much in common but they are two entirely different beasts! The market will often respond to economic news but not always in the way you might think. The key distinguishing factor is that the market looks forward and the economy is typically telling us what has already happened.

In summation, we’re still struggling economically folks. There is a lot of work to be done and it will take time. It’s not a stretch to say that the real recovery we’ve seen has actually been somewhat anemic so don’t let headlines lure you into thinking we’re out of the woods. Stocks will take a break if they haven’t already begun showing signs of it the last few weeks. Bonds have been stung and although the road is still bumpy this recent correction may be overdone. Interest rates will eventually rise some more but don’t count on it at a frenetic pace or anytime too soon; the economy would simply come to a standstill and this technical definition of a recession (negative growth) would quickly come into play. The Fed and many interested politicians won’t let that happen. This leaves us with a common question:

“So…where then am I supposed to put my money?” Most anyone can tell you to trim stocks or sell bonds.  That’s part of the answer and one that we feel is fairly obvious and telegraphed. The remainder of the solution rests with what we have been talking about as our central theme for all of 2013. Look hard at Alternative Investments. We’ve touched on this several times with several articles and thoughts to consider. For specific details on how you can apply this critical asset class to your portfolio feel free to contact us directly.  In the meantime…let Mr. Market do his thing and continue to whipsaw folks into more confusion…