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Strap In for an Extended, Slow Recovery

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By Nancy Trejos
Washington Post Staff Writer
Sunday, October 12, 2008

It has become a familiar refrain among financial advisers and investment strategists: The stock market may go down, but it always recovers over time.

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If history has proved anything, it's that sometimes, it takes a really long time.

Take the bear market of 1967. That dragged on for 15 years. The Great Depression was called great for a reason: It took 30 years for the market to bounce back. Look at Japan, and you'll find that the Nikkei stock market index has yet to recoup its losses from its crash of 1990.

It's no wonder that investors now are fearing a prolonged and painful rut. Already, the Dow Jones industrial average is down more than 36 percent for the year.

"You could be in it for a long time, five or 10 years, before the Dow starts to rally," said Doug Roberts, founder and chief investment strategist of Channel Capital Research Institute in Shrewsbury, N.J.

Or more. There's no telling how long it will take, but one thing is certain, economists and analysts said. A stock market recovery will depend on how quickly and effectively the government can solve the problems that have crippled the U.S. financial system. That means injecting liquidity into the financial system, getting banks the capital to start lending again and doing so without fueling inflation, they said.

"The question is, are we in an extended period where the stock market goes nowhere for a decade or more like the 1970s and 1980, or are we going to see a rather quick recovery this time?" said Nigel Gault, chief U.S. economist at Global Insight, a research firm in Massachusetts. "We know there's a recession coming, we know the next year is not going to be good, I think a lot of it depends on what we do after that. How we manage to deal, how we rebuild the financial system. And when we get back, will we be able to do so without the explosion of inflation?"

So should you, even after the latest declines, hop out of the market to save yourself still steeper losses? Most financial experts think tinkering with your portfolio is still a better defense than cutting and running. Christine Fahlund, a senior financial planner at T. Rowe Price, said people must prepare themselves for a possible recession by cutting back on unnecessary spending and saving more. But they shouldn't stop contributing to their retirement plans. Nor should they pull too much money out of stocks and flock to safer investments such as Treasury bills that won't beat inflation.

"If they can't bring themselves to put it in the stock market, they at least have to be putting it into bonds and money markets," she said.

For those feeling queasy about the economy right now, don't jump to too many conclusions, Gault said. Another Great Depression for the United States is unlikely, if anything because the market has not dropped to that extent -- up to 90 percent. He and other economists also blame the federal government for exacerbating the depression. Among the mistakes: The Federal Reserve tightened monetary policy, and Congress implemented protectionist trade legislation.

But a repeat of the 1967 bear market or even an echo of the Japanese stagnation cannot be ruled out, Gault said. The 1967 bear market ushered in a period of stagflation and coincided with the energy crisis of the 1970s and the high unemployment rates of the early 1980s. The Japanese slowdown was also caused partly by the bursting of a real estate bubble. Stock prices, too, were inflated.

"You could end up in a Japan situation where you essentially go nowhere for a decade or you end up in the '60s and '70s, where you try to inflate your way out of it," Gault said.

Bob Froehlich, vice chairman of DWS Investments, sees neither scenario playing out because the U.S. government and governments throughout the world have stepped in to save their banks and cut interest rates.

"The difference that I see happening now that didn't see happen in Japan, or that didn't happen in the U.S. in the '20s or even in the '60s, is we're looking at a synchronized global policy response to this crisis," he said.

Charles McMillion, president and chief economist of MBG Information Services, a District-based business forecasting firm, said this slowdown has unique characteristics. That's because Americans are in a lot more debt than ever before, while their assets are declining, their wages are stagnating and the cost of living is skyrocketing.

"For a number of years, households have just been placed under unprecedented financial pressure," he said. "We've never had anything remotely like this."

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