The economy is in awful shape right now, but it is not in a terminal decline from which it will never recover. We have faced hard times before and always managed to come out stronger on the other side. While I do believe in happy endings, I do not look for one right around the corner.
Waiting for the recovery does not mean sitting on your hands and doing nothing. There are things that you can be doing today to help yourself prosper for the long run. Indeed, now may be the best time in your life to make moves that will help you have greater wealth later in life.
The stock market almost always turns up before the economy does. Trying to pick the absolute bottom is a fool's game. We are far enough along in the process that it is time to start tiptoeing back into the market.
Remember that a bear market is a long term investor's best friend. Only in bear markets do serious values appear.
Why the Recovery Will be Slow
The timing and shape of the eventual recovery will play a very important role in the success of your portfolio. In trying to figure out how and when the recession will end, it is useful to look at how other recessions have come to an end.
In every recession, the part of the economy that gets moving first is residential investment, which is mostly the construction of new houses. Existing home sales, which make up about 7 of every 8 home transactions, also tend to start rising at the same time. (Existing home sales, however, are pretty much irrelevant to GDP growth since no construction is taking place.)
The graph below shows that both new and existing home sales tend to bottom in recessions and then rise sharply, helping to drive the economy out of the recession. The dramatic decline in both was the biggest clue that a recession was coming.
The next thing to get going is consumer spending, particularly on big ticket stuff that people do not buy every day. The classic example of this is auto sales.
Business investment tends to lag behind and, at best, moves with the overall economy (e.g. software and equipment investment) or after the rebound has firmly started (e.g. investment in new office buildings and stores).
The unemployment rate lags economic cycles and tends to rise even after a recovery gets underway. Still, employment will normally start to improve faster than investment in non-residential structures. Non-residential construction has just started to turn down, and has much further to fall.
Home Prices, Not Starts, Are Key
So, with February's shocking news that new home starts jumped by 22.2% over January; does it mean that happy times are here again? Sadly no, and I actually consider this to be extremely bad news.
At the January sales pace (the February data will be released on Wednesday), it would take 13.3 months to clear the existing inventory of new houses. Never before in history has the months of supply of new houses even exceeded a year.
So while in the short term, the rise in starts is good news for the homebuilders like D.R. Horton, Inc. (DHI) and Lennar Corporation (LEN), over the longer term it is bad news. Do not pay attention to the recent speculation into these companies, or in the major suppliers to them, like Masco Corporation (MAS) or Fortune Brands, Inc. (FO).
Put another way, we have to remember the first law of holes. If you find yourself in one, stop digging. In this case literally, we need to stop digging new foundations.
Now perhaps it is not quite as bad as the numbers look at first blush. Housing starts are a notoriously inexact statistic. However, in the absence of better information we have to assume the up 22.2% number is correct. Also, most of the new construction being started is for apartments and condos. Single family starts were only up 1.1%, while starts in structures with 5 or more units were up 79.7%.
These new apartments and condos will be competing with the existing stock of new houses for sale, and with existing homes, and increasing number of which are distressed sales, in or near foreclosure.
