Streetwise for Friday, September 21, 2018

A so-called bull market does not die of old age. Instead, it begins to wither and waste away in anticipation of, or because of an economic slowdown. So, we need to look to the economy for answers as to what causes the economic chain reaction that results in both a recession and the death of the bull market.

Let’s begin with what you probably already know. Our economy, as is the case with most modern developed economies, follows a cyclic path, often referred to as a business cycle, or the downward and upward movement of our gross domestic product around its long-term growth trend.

The length of a business cycle is the period containing a single boom and contraction in sequence. These fluctuations typically involve shifts over time between periods of relatively rapid economic growth and periods of relative stagnation or decline.

Contrary to what some would have you believe it is impossible forecast with any accuracy when the current stage of a cycle will end, and the next stage begins.

What we do know is that at some point we will begin to see signs of economic strain.  Corporations will push to increase output beyond what is sustainable long-term. Wages will rise as the demand for workers exceeds what a specific labor pool can deliver. The result is an upward wage spiral.

One factor driving labor scarcity is the inability to obtain foreign workers due to immigration restrictions. Factors of production, including raw materials become scarcer and more expensive as demand increases. Tariffs are aggravating this problem as they add to the price level and reduce availability.

The net result is that inflation will rise to the extent that it gives the Federal Reserve heartburn. And you know what comes next, an acceleration of higher interest rates.

The Fed’s objective of course is to reduce economic activity to the point where inflation falls back to a level it can live with. And as the economy slows corporate profits are reduced and Wall Street moves from a bullish to a bearish outlook on life.

Will we see a bear market this year? No, I do not believe so. Moreover, the probability of the economy sliding into a recession of any kind before the year 2020 has a low probability.

Yet, a “correction,” if or when it comes, is not the end of life as we know it. With the Fed reining in the supply of cheap money and interest rates poised to rise, companies will need to up their game.

At the same time, it will become easier for you distinguish between companies whose margins are driven by solid business models, growth prospects and effective management teams; as opposed to those who have relied too heavily on low interest rates to artificially buoy profitability.

You can then exploit the ensuing volatility that is likely to occur for building positions in companies that have long-term staying power in the changing environment.

It might sound counterintuitive, but there is really no reason to panic during any downturn in the equity markets. Corrections are one of the best times to add to your equity allocation. And over the long term, maintaining a strategic position in equities has been shown to be the most efficient way to preserve purchasing power.

By bracing for a correction-and understanding that they’re usually of a short-turn nature, you will gain the confidence necessary to maintain your equity positions and will likely to be rewarded over time for your patience. However, to be successful you must act opposite to what everyone else is doing.

You want to capitalize on the emotions of the crowd by finding quality stocks at low prices during any sort of a market downturn. In other words, investing is about taking advantage of the fear and greed in others.

Note to Readers: I will again be teaching Introductory Investment Analysis for the Ringling College’s Lifelong Learning Academy, now called the Osher Lifelong Learning Institute. Classes begin on Monday, October 1, (new date due to my requiring surgery) and will run every Monday for 8 weeks. Call 941-309-5111 or go to https://olliringlingcollege.org to register.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.