Is a Double Dip Recession Looming?
Today it appears that the major topic on investors’ minds is the potential implication of a double-dip recession. While no one can be certain what will happen, we can identify some important signposts that might point the way to what could unfold. Let’s start by examining how often double-dip recessions have occurred. The reality is that they are extraordinarily rare. Since 1854, there have only been three in the United States: in 1913, 1920 and 1981. All three occurred during periods of tightening central monetary policy which stands in stark contrast to today. The first, 1913, came during the birth of the Federal Reserve which was prompted by the severe banking crises of the previous decade. The latter two occurred during a period of rapidly escalating inflation, which does not seem to be a concern at the moment.
If we avoid a double dip recession, one can reasonably surmise that credit quality will improve as the economy begins to grow (albeit slowly) and less American workers lose their jobs. A potential counter balance to improving credit quality will be the rising interest rates that could negatively impact fixed income prices While high quality, higher yielding instruments may also fall in price, they typically fall less than low yielding instruments and offer significantly more current income. If interest rates don’t rise (and we also don’t see a double-dip) the increases in yield will improve portfolio returns without the price-risk associated with a rising interest rate environment.
What if history is wrong and we do experience a double-dip? Given that previous double-dip periods had substantially different circumstances we will be to a great extent in uncharted waters, but we certainly can speculate. Another downturn in economic growth will likely punish equities and most commodities as it implies shriveling end-demand. Low yield, fixed income instruments should rise in price but will offer little in current income as yields are already at, or close to, historical lows. Such an environment would likely make investors very defensive and fall back to cash and CDs to avoid capital losses. Higher yielding fixed income opportunities would remain for investors who focus on higher quality credit. These particular instruments would likely rise in value and produce enhanced monthly income during a period of turbulence.
Double dip or slow economic growth? Let us know what you think!
The above is for informational purposes only and represents the opinion of the author and is not investment advice, is not specific to any investor’s financial situation and may not be suitable for any investor. Before investing, you should consult with the appropriate advisors.
Wednesday, September 15th, 2010 at 3:12 pm