When Will the Economy Rebound?

2008, One of the toughest years since the invention of money, is drawing to a close. The sharp downward momentum for the last few months in the Dow Jones index has reflected the dwindling corporate and consumer confidence in the current economy.

On the other hand, there are many tempting opportunities to buy stocks and follow Warren Buffet’s advice to Be greedy when others are fearful and fearful when others are greedy.

Although for most trading days the market hasn’t dipped below 8,000 points, how can investors and non-investors alike really know that the worst is behind us.

Here are 3 time-tested indicators that would signify the end of the recession:

1) The TED Spread(T-Bills and the EuroDollar futures), which is the difference between the interest rate that the banks borrow from each other and interest rate on 3-month Treasury bills. The larger the TED spread, the less likely are the banks to deal with each other. The spread is currently at 2.18 and a figure of 1 or lower would signify a recovery.

2) Follow the Real Estate market since currently the housing inventory levels are at more than 10 months worth and a recovery would have less than 6 months worth.

3) The unemployment rate has been relatively high in the last year, now at 6.7%. A consistent trend toward 5% and lower would indicate a recovery.

So hang on tight and follow the data, as the economy eventually will bounce back.

Dividend-related Investing in Tough Economic Times

I had a friend ask me on how they should spend money in the stock market with its recent ups and downs. Although I cannot give exact recommendations for which companies to invest in, here is some information on one investment strategy for those who are looking for deals in the stock market and can afford to invest.

On the one hand, it is reasonable to think that public companies should take the capital they raise from selling stock and reinvest it back entirely.

However, the reality is that a significant portion of that money often ends up as waste due to failed business decisions such as unsuccessful product launches, bad acquisitions etc’. On the other hand, businesses that consistently pay and increase their dividends through time are often regarded as more fiscally and operationally responsible than companies that don’t pay any dividends.

Companies that offer dividends are showing a level of confidence that their operations can meet financial goals, and confidence is the key attribute that investors look for, especially in turbulent economic times. Dividends also cannot be concocted by some accounting measure, which allows investors to conclude that the company’s earnings are legitimate.

Additionally, in most cases, companies cannot keep growing since any marketplace does have its limits. Therefore, instead of expanding into other non-related products and markets, it’s more worthwhile for a company to pay out dividends. All this is in keeping with the key for a long term success for a company, that of being able to balance the needs of shareholders, management, and the enterprise.

There is a general misconception about dividend stocks that they can be “boring” or simply don’t perform as well as non-dividend stocks. Ned Davis Research shows a good representation of how dividend paying stocks have outperformed non-dividend paying stocks over the past 35 years, which includes 4 prior recessions.

Combine this information with the fact that many stocks of high-quality dividend-paying companies have recently reached historically low prices and you may keep this in mind an investment strategy for the foreseeable future.

Is This Recession Really Different ?

The current financial crisis has affected investors worldwide. The common belief is that the US housing meltdown has rippled globally to cause financial institutions to default and a cause the credit crunch.

In response, governments in North America, Europe and Asia have offered rescue bailouts in the billions to these institutions and far-reaching guarantees to consumers. In addition, drastic interest rate cuts have been implemented in an effort to soften the slowing economy. At last, there are encouraging signs that these initiatives in their totality have finally started to show signs of effectiveness.

Although the recession cloud is upon us, there are several signs of a silver lining. Here are the good indicators showing that this recession isn’t likely to be a severe one, let alone a depression.

Indications that credit is starting re-flow:

An active economy is heavily reliant on credit lending, by both large institutions and individuals.  When credit markets froze earlier this year, most businesses started running out of money. That is why it was crucial to reinvigorate the credit system to become as seamless as it was in the past.

  • The lending rate that banks use to lend to one another, known as the London Interbank Offer Rate (LIBOR), has decreased from a peak of 6.88% earlier this month to less than 1.3%. The lower rate signifies a higher propensity for lending.
  •  The spread between 3-month LIBOR and U.S. Treasuries (the risk-free rate) decreased from a record high 4.65% earlier this month to 2.7%. A narrower spread indicates that banks are more willing to lend to each other.

Better Indications for US Housing:

The housing market represents one of the fundamentals of the economy and house prices correlate directly with good and bad economic times. Clearly the housing market is still volatile but some encouraging news have emerged.

  • U.S. fixed-mortgage rates has been decreasing, which helps qualify more borrowers
  • Fed rate cuts are causing variable rates to continue decreasing
  • Continued Oil and gas price declines result in more affordable heating costs for homeowners as we head into the winter months
  • Data from August and September shows a reduction of US home inventory. The 10.6 months supply of homes in August moved down to 9.9 months supply in September. The lower the inventory, the higher the home value
  • The FDIC and the U.S. Treasury are working on a proposed plan to prevent additional foreclosures by offering guarantees to lenders and mortgage providers. There is also talk of a rescue plan for the mortgage owners in a form of a stimulus, court intervention in mortgage agreements and other solutions.

There is good reasons to still believe this recession will last beyond 2008, but it’s also important to remember that the equity markets are often leading indicators of the economy. Therefore, good news as provided above, can be seen as a positive start to a credit market recovery and the housing crisis reaching a bottom.

Historically, markets have retracted prior to and in the early stages of recessions. After such a period, the markets tended to rise quickly and subsequently economic recovery ensued. On average, most recessions last between 12 to 16 months, so even if only a third of the recession is behind us it is likely that more signs of recovery will appear in the coming months.

Combine these statistics with a likely fiscal environment that supports deficit spending and additional government investments on a massive scale to grow the economy once again. While the risk-adverse investor might not wish be fully invested in the stock market during a recession that is priced in, it is wise to have at least some of your equity there to benefit from the inevitable climb back to prosperity.

The Finanacial Turmoil and Recency Effect

Since we are in the midst of a recession, and anyone denying it is really hanging on to technicalities, it’s easy to fall into the recency bias trap. The recency effect, which is a term borrowed from the psychology discipline, refers to the tendency of people to remember recent events more vividly and give them a higher consideration than historical information. Unfortunately the recency bias could result in the abandoning of logical thinking when it comes to long-term financial strategies.

Here are some examples of the recency bias when it comes to investing:

* Deciding to keep money at home( in the mattress, a safe, etc’) as opposed to depositing it in the bank and letting it earn interest.

* You decide to transfer your money into “better” investments, such as bonds and gold

* You decide to cash out of your retirement savings.

Whenever a person makes this type of decision, they are allowing recent event to directly affect their long-term planning to the point of abandoning what was once considered a sound strategy. Although, you may be right in changing your approach, this is highly unlikely.

The following are the likely results:

* Your bank doesn’t declare bankruptcy and you missed out on the interest while your money was at home.

* The stock exchange begins to recover and in the meantime bonds and gold start declining. You then move your money back into stocks which leaves you paying more in the end.

* You pay taxes and penalty fees for early withdrawal from your retirement account. Stocks recover and you are left behind on gains you could have made.

Allowing news and events to drive your strategy is never a recommended. Instead, you should come up with a strategy that will withstand both the highs and lows of the market. For example:

* Select the right asset management that is right for your time horizon and risk tolerance threshold

* Regularly contribute money to your portfolio

* Reanalyze and balance your portfolio annually

The only time to actually move out of the financial market is if your individual stocks are showing obvious signs of crashing beyond repair.

Having knee jerk reactions to financial news is not a wise decision. History, we have to remember, is a good teacher of this.

Chew on this – Tip #3. A Blog for the times

For the current economic crisis, I would like to mention a blog that I came across as being focused on the topic and presenting the information with the consumer in mind first and foremost. The Talk Money Blog  discusses such pressing issues as: money saving tactics, debt problems and solutions, the mortgage meltdown, the credit crunch and its impact, finance contracts, and how to claim compensation for wrongful bank or credit card charges.

The blog’s author is Mark Aucamp, who has worked in Africa, Asia, and Europe, and is experienced as the owner of a debt management business  and as a mortgage consultant running his own company.

Some of the informative blog articles include the “Buy to Let Landlords“, “money saving tips – free enterprise”, and “Credit Cards Debts Cleared Legally“.

There is also a forum section within the blog that is divided into sections of: The Mortgage Market, The Credit Crunch, Money Saving Tips, Unenforceable Finance Contracts, and Debt Management.

The site itself is slick looking and easy to navigate. It also isn’t bombarded with ads, just a couple of banners and some Google Adsense ads, which make for an unobtrusive reading.

Overall, the site shows good potential, as it was launched in early July and already contains many extensive posts and relevant comments relating to the current economic crisis.