Recession Predictions and Investment Decisions

Successful investing is about looking ahead, and determining whether an economy is in a recession involves looking behind. By the time a recession has started, the economy might be getting better, making it a good time to invest.
Successful investing is about looking ahead, and determining whether an economy is in a recession involves looking behind. By the time a recession has started, the economy might be getting better, making it a good time to invest. (By Richard Drew -- Associated Press)
By Allan Sloan
Tuesday, December 11, 2007

Everyone and his brother seems to be talking about recession these days. It dominates every public investment discussion and is the topic 24/7 on cable TV. But let me tell you a little secret: When it comes to investing, the question of whether we're in a recession (or are heading for one) just doesn't matter.

How in the name of Alan Greenspan, Ben Bernanke, and all the other economic saints and seers can I be so dismissive of something that's attracting so much attention? Because while the economy obviously matters a lot, both politically and economically, the "R" word is irrelevant when you want to know how to place bets on the markets.

Gather around the campfire, folks, and I'll tell you why.

It's actually elementary. Investing successfully is about looking ahead, while determining whether we're in a recession involves looking behind. Way behind. We won't know that a recession has started until months after it's begun. And by that time, things in the economy may well be getting better rather than worse, which might make it a good time to invest.

Exactly what is a recession? Opinions vary. Many people think a recession is defined as two consecutive quarters in which real gross domestic product, GDP adjusted for inflation, declines. If you accept that definition, which I don't, you don't find out that a recession is underway until six months -- two calendar quarters -- after it has started. (Sorry, too late!) If you use what I consider the proper definition, a declaration by the National Bureau of Economic Research's business-cycle-dating committee that the economy has peaked, you may have to wait even longer. Nevertheless, I prefer the NBER version because it's the collective opinion of seven savvy people rather than a rote formula.

"We wait long enough so that the existence of a recession is not at all in doubt," Bob Hall, a Stanford University business professor who chairs the cycle-dating committee, told me in an e-mail. "We concentrate on finding the date of the peak in activity, usually at a time the press [has] lost interest in the question of whether we are in a downturn." Typically, Hall wrote, the committee makes its call six to 18 months after the downturn started or economic activity peaked, depending on your point of view.

I won't bore you with all the grubby details, which you can find at http://www.nber.org. One thing that will leap out at you is the contrast between economic reality and what many people believe. For example, conventional wisdom is that the devastation wrought on Sept. 11, 2001, sent the U.S. economy into a tailspin. The reality, according to NBER, is that the economy was already in a recession, which had started in March 2001 (or, some committee members now think, even earlier) and ended in November -- two months after Sept. 11. The committee, however, didn't announce this until July 17, 2003. By then, the popular assumptions about the effects of Sept. 11 were set in stone.

I'm not naive, and I know that the question of whether there's a recession has enormous political implications for the 2008 elections, which is a major reason so many of my colleagues in the media are obsessed with it. But we're talking about investments here, not politics.

I have no idea if we're in a recession or heading for one. Nor do I know where the market is going over the next few months. If I did, would I tell you for 35 cents? What I do know is that if you want to do well in the market, you've got to think ahead, not behind. The "R" word isn't helpful. What you need is the "F" word: foresight.

* * *

FOLLOW UP: You'll be glad to know that the Treasury is taking action to deal with the looming tax loophole represented by exchange traded notes, the subject I discussed with you two weeks ago.

Last Friday, the Treasury issued a revenue ruling that said that ETNs involving foreign currency generate taxable interest income that must be reported each year. The Treasury also issued a tax notice seeking comments about whether it should do the same for other ETNs, those involving securities and commodities. Although the notice is written in tax-ese, a highly technical language spoken only by tax professionals, people who translated it into English for me said the notice suggests that the Treasury will issue regulations in the future providing that these ETNs, too, generate taxable income each year. Close those loopholes, guys. Way to go!

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address isasloan@ fortunemail.com.


© 2007 The Washington Post Company