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How Trouble Gives Way To New Trials

By Jane Bryant Quinn
Sunday, May 10, 2009

After all the blood, tears and recriminations, is the Great Recession over?

"Not yet, but sooner than you think," says economist Lakshman Achuthan, managing director of the Economic Cycle Research Institute in New York City. Only a small amount of government stimulus has reached the economy so far, but "the business cycle doesn't wait for policymakers," Achuthan says.

The institute's U.S. Long Leading and Weekly Leading indexes are up significantly from their December lows. In 16 of the past 17 downturns, this sequence of upturns has correctly forecast a recovery in about four months. (The exception: 1930, so there's something in the record for pessimists, too.)

If growth does resume, you can thank the government's massive policy response.

The Federal Reserve slashed the federal funds rate from 5.25 percent in August 2007 to 0.25 percent today. (That's the rate banks charge for lending money to each other overnight.) The Treasury Department, for all the abuse it has taken in two administrations, saved the banking system from collapse. The stimulus package is boosting the natural, cyclical forces that bring recessions to an end.

These efforts in the United States have been mirrored everywhere in the industrial and developing world. No one is saying the economy will return to robust health anytime soon. At the very least, however, businesses might begin to rebuild their depleted inventories. That would give manufacturing a better tone and, perhaps, create new jobs. Construction spending also starts up before a recession ends.

Alternatively, another financial accident might freeze credit again, and we would be back in the pits. Even a recovery might come too late for investors nearing retirement age whose investments are toast.

The big question about investors and consumers is whether the recession has marked them in any way. Was the suddenness of the global breakdown so shocking, and the consequences so painful, that Americans will change their saving and spending habits? Or will they shake off their fright and return to life as it was B.C. (Before Collapse)?

At the moment, financial planners report that their clients -- young and old -- are behaving more conservatively. Families are curbing spending, paying down debt, increasing their savings and investing cautiously. Call this strategy Plan B, the place you retreat to in the face of uncertainty and loss.

Even among baby boomer millionaires, 50 percent intend to hold more of their retirement portfolios in cash, according to a survey conducted by the Spectrem Group, a Chicago consulting firm. Whether that intention survives a new bull market remains to be seen. It probably should -- if not in cash, then certainly in bonds.

Odds are that you've been over-invested in equities. At the end of 2007, almost one in four workers between 56 and 65 held more than 90 percent of their 401(k) in stock, according to the Employee Benefit Research Institute in Washington. More than two in five held more than 70 percent in stock. They will be well into Social Security before recovering their losses.

Maybe these 401(k) holders managed their risk by owning a bond portfolio on the side, but I doubt it. More likely, they're investing aggressively, in hope of making up for the fact that they started serious saving late. They gambled and lost. The market does not respect your personal need to make money in a hurry.

On the other end of the investment spectrum, younger and lower-paid employees with 401(k)s are doing better than you might think. Accounts worth less than $10,000 grew an average of 40 percent in 2008, because workers continued making contributions. The new money they put into their plans more than covered the market loss.

If the recession is indeed near its end, stocks will continue trending up. But "the past may not be prologue," says market analyst Steve Leuthold of the Leuthold Group in Minneapolis. Future returns may lag behind the market's historical returns, he says, because of the mature state of the U.S. economy.

In general, growth in corporate earnings and gross domestic product are the primary factors driving a nation's long-term stock market performance. Leuthold sees annual GDP rising in the 2 or 3 percent range, compared with 5 or 6 percent during America's days of emerging growth and global leadership.

Western Europe is also mature and, arguably, so is Japan. That leaves the developing countries in Asia, Latin America and Eastern Europe. You might have sworn off them after they got clobbered last year. But they remain the parts of the world with the highest potential for growth. A Plan B investor will own them in moderation, balanced with safer investments such as quality bonds, including inflation-protected Treasuries.

If you lost your job or saw your income chopped, Plan B is the only way to go. For those still standing, the message is the same. There's a lot of struggle left in the economy and the global financial system. When we muddle out of this recession, the Fed will have to fight inflation, with unknowable results. The times call for more savings, less debt and a ready-for-anything investment mix.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis contributed to this column.

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