Where’s the economy going?

Everyone is asking where we go from here. The only certain response is: nobody knows.We’ve heard repeatedly that the world changed on September 11th. Several business leaders picked up that theme, including Robert Milton of Air Canada when he announced massive layoffs and cutbacks in the flying schedule recently.But what does that mean precisely? And what are the implications for us personally and as investors?

What we know
Let’s start with what we know: This is the first time in our lives North Americans have felt threatened on two critical fronts:

• Our economic well-being
• Our personal safety.

The last time people on this continent felt widespread fear for themselves and their families was during the Cold War-especially the Cuban Missile Crisis. The response was to build backyard fallout shelters and to stockpile food. But that wasn’t combined with any serious economic threat. Except for an occasional blip, the economy and the stock markets moved steadily ahead in that period.

Plunged into recession
So the mass psychology we’re faced with now is virtually unprecented. We don’t know how it will play out, but we do know from past experience that when people feel threatened in any way, they tend to retreat into a shell, curtail spending except on necessities, and increase their savings.

We’re seeing evidence that this is what’s happening now.

The second thing we know with virtual certainty is that we’ve been plunged into a recession. Almost every economist and politician agrees on that point. And we can see the stark evidence of it in the massive layoff announcements that are coming on a daily basis.

Canadian economy contracts
If we needed any more proof, it was the release on September 28th of our July GDP numbers. These showed the economy contracting by 0.1 per cent, the second straight month of decline. What do you imagine the September number is going to look like?

The third reality is that the threat to our society is not going to go away soon. It is deeply rooted and will be extremely difficult to deal with. President George W. Bush and his government have been very clear that we’re in for along struggle here.

Three economic scenarios
Based on these realities, there are three possible economic scenarios.

1) The V scenario:
This is the optimistic view. We’ll have a short, sharp recession, followed by an almost equally sharp recovery that will begin in 2002.

For this to happen, we have to assume the following:

• The threat of further terrorist attacks on this continent will be seen by the public as having greatly diminished
• The tax and interest rate cuts will re-stimulate consumer spending
• Government bailouts will prevent major companies from collapsing and restore investor confidence in such vulnerable industries as the airlines.

The price of all this will probably be budget deficits in both the U.S. and Canada. But that would be regarded as a small price to pay in the circumstances.

2) The U scenario:
This is the middle-of-the-road position. The recession will be longer and deeper, with no real recovery before 2003.

This scenario assumes that:

• Consumer confidence will be much slower to return
• We will see more layoffs and some major corporations go under
• The threat to our personal safety and security will be slow to fade.

On the positive side, it also assumes no major shooting war.

3) The L scenario:
This is the pessimistic view. We will have a major fall in economic activity, followed by an achingly long period in which we grind along with high unemployment, consumer despondency, and continued security threats.

It could be years before we emerge on the other side. Think Japan, which has alternated between slow growth and recession for more than a decade.

If you want to really be discouraged, think about the 1930s. No one is using the ‘d’ word yet, but a depression (which is really just a deeper and more prolonged recession) can’t be ruled out. We came perilously close to one in the early 1980s.

Impact on investors
There is no way of knowing which of these scenarios will prevail. But one of them will. And each has different implications for investors.

For example:

• If you think either the U or L scenarios is most likely, you should be a seller of stocks on any market rally and a buyer of bonds.
• If you think V is more likely, you should be a buyer of quality stocks on weakness.

In short, decide for yourself where you believe we are heading. Then tailor your portfolio and your buy/sell decisions to your comfort level and your expectations.

From the Oct. 1, 2001 issue of the Internet Wealth Builder.