The Great Depression? - What should you do if you really think we are headed there?

Here's the latest from Dave Simonds:

Hello “Dollars and Sense” listeners,
...Earlier this month the government reported that our nation’s unemployment rate jumped from 6.1% to 6.5%, a larger increase than anticipated. The Dow Jones Industrial Average promptly rose more than 250 points that day.
Today, government data showed that our economy contracted in the 3rd quarter at an annual rate of -0.5%, worse than expected. A few minutes later, another report showed that home prices plummeted by the largest annual rate on record, down more than 16% from a year ago. One economist followed up the reports by solemnly observing, “As bad as the 3rd quarter was, the 4th quarter will undoubtedly be worse.” The market was poised for a lower opening but suddenly turned higher after the dour numbers were reported and posted modestly positive gains at the end of the day.
Yes, you are reading this correctly. The market is moving higher AFTER the release of doom-and-gloom economic numbers. This gets right to the heart of what I’ve been discussing constantly in recent weeks, particularly on the “Dollars and Sense” show. The market has already factored in a fairly serious recession, so when the figures are actually released the market gives a collective shrug as if to say, “Yeah, we knew that. So what?” Think of it this way. The S&P had already fallen a jaw-dropping 41% from 9-1-08 through 11-20-08, the largest decline in history over a 3-month period. Don’t you think the market was already anticipating some pretty bad news?

So that gets us to the most important question of the day: where are we heading from here?

Actually, it’s quite simple.

The economy is either heading into The Great Depression Revisited…or we’re not.

Stocks and bonds are either poised to drop considerably lower…or they’re not.

I don’t mean to sound so flippant and cavalier about it, but our future really boils down to such a simplistic outlook. The market has priced in a weakening economy and it has been spot on with its forward looking call, but it has NOT priced in a 1930s-style economy. So I get back to the original thesis: we’re either on a downward spiral that will potentially see stocks drop at least another 30%-50%, or we’ve seen the worst of the Great Bear of ’08 and the market will begin moving higher even as the headlines continue to drip with fear and angst.

Here’s how investors should treat each of those two scenarios.

1) The Great Depression: The Sequel.
Sell all stocks. Invest only in government-backed bonds and gold. That’s it, not even CD’s. In a severe depression the government will not be able to save the banking system, which would include its inability to pay off all insured deposits. It would first have to pay the interest on its own debt to satisfy all the foreign governments that own our bonds. You could keep a little in cash but not much because the dollar will lose much of its value. For more extreme pessimists, load up on non-perishable food items and sell your home immediately. Find a nice apartment to rent for a couple of years and then start looking for a home after prices have dropped another 20%-40%.
(Some of you may chuckle when reading this, but these kinds of doomsday scenarios are getting a lot of traction these days. I know because I get e-mails from radio show listeners convinced we’re heading into an economy worse than the 1930s. I also lurk on various investment-related chat rooms where financial Armageddon is the theme of the day. These are the same chat rooms, by the way, that were chock full of the New Economy rhetoric of 10 years ago that was eventually discredited. There was an article on marketwatch.com today that spoke about the coming 100-year bear market. It’s a little nutty out there, folks.)

2) Deep Recession.
I’ve already pointed out that investors have collectively factored in some of the worst economic news we’ve seen in many decades. The easiest prediction to make right now is that the news will get worse before it gets better. Some economists are predicting unemployment to rise toward 10%, only the 3rd time in history that we would hit double digits in that category. Go to the investment section of any bookstore and you’ll see the growing number of tomes dedicated to the coming crash. There’s no question that stock prices already reflect a worsening economy that most of us are anticipating. Today’s poor numbers are so yesterday!

Based on the evidence we have before us today, while extrapolating for possibilities down the road, I do NOT believe we’re crashing toward the first scenario.

I can’t say with any certainty how bad the recession might become, but I definitely acknowledge the possibility that conditions could deteriorate well into 2009. (Barak Obama may find himself asking, “And why did I want to do this exactly?” However, if conditions improve through the 2nd half of his term, which I expect, then he would likely coast to victory in 2012. But I’m getting WAY ahead of myself.)
As I’ve mentioned before, stocks AND bonds will likely rise in the next upswing since both have been trashed in recent months. Today is a perfect example as both asset classes exhibited positive returns today. We don’t feel the need to add to our stock positions at the present time as there’s still enough risk in the market to remain on high alert, and bonds SHOULD give us the support that they frankly did not give us in September and October. Moderate allocation models are doing well in relative terms here in November and we don’t feel any rush to change that.
This is definitely the most trying time financially that any of us have ever seen, but I continue to strongly believe that most, if not all, the damage is behind us. However, here’s a warning. Another market like this and I may go back to working the graveyard shift at a local gas station, something that I did during my college days in the early 1980s. That stint included a death-defying robbery where I had a gun pointed at my chest, the robber yelling at me while I was unloading the cash register, “You must not want to live, you’re not moving fast enough!” At least that incident only lasted a few seconds. Here’s hoping that this bear market, aka “The Great Wall Street Robbery,” is also close to running its course. (In case you’re wondering, they never caught the guy. But I did get my name in the paper!)
Have a blessed Thanksgiving!
Dave
David W. Simons, CFPâ