Don't Panic (August 2011 edition)

The equity markets have been reeling for the past weeks, and today they were particularly savaged as additional fears of impending economic doom took over. The Dow Jones Industrial Average plummeted 512 points, and the S&P 500 index dropped a whopping 60 points (an even greater drop in terms of percentage than that of the Dow). The drop sent the markets into "correction" territory (defined as a pullback of 10% from most-recent highs). Both indexes are now in negative territory for the year, and the Dow closed at its lowest point in six months.

Markets began sliding as the artificial crisis over the debt ceiling intensified -- we call it an "artificial crisis" because politicians on both sides of the aisle explicitly threatened that the US would "default" on its debt obligations if a resolution was not reached by the arbitrarily-selected August 2nd deadline, a possibility that we showed was utterly ridiculous (see this previous post).

Now that a debt-ceiling deal has been reached, markets have shifted their angst to the ongoing weak economic reports, including a weak GDP number (the first estimate of US 2nd quarter GDP came out this past Friday at a meager 1.3% annual rate of growth), weak numbers for ISM manufacturing and non-manufacturing for the month of July (50.9 for ISM manufacturing and 52.7 for non-manufacturing), and another disappointing jobs number (400,000 unemployment insurance claims for the week ending July 30, as reported today). The ongoing fears about sovereign debt in Europe are adding to fears that a major economic catastrophe is just around the corner.

However, we believe that fears of impending Armageddon are ill-founded and overblown. For starters, we would argue that ham-handed government interference with the economy in the US, including "stimulus" spending and sharp increases in regulation, have hampered the economic growth that would otherwise have been stronger. However, we believe the recent debt-ceiling debates reveal that the American people and their elected representatives are now sharply focused on the question of spending in a way not previously seen in this country. For some insightful commentary on the debt-ceiling deal from an economist we respect, we would advise investors to check out the video entitled "We have a deal" by Brian Wesbury.

Further, while the government's inept intrusions have hampered growth, the economy is still growing (albeit slower than anyone would like, and certainly slower than it otherwise could). While 1.3% expansion is nothing to write home about, it is expansion. Similarly, both of the ISM numbers noted above indicate expansion as well, just at a slower pace than expected.

We would also point out that the red line above, which indicates GDP growth, continues a fairly steep increase, while the stock markets continue to trade as though we were no better off today than we were in 1997. If you look at the blue line, representing the S&P 500 index as of close of markets yesterday, and trace its current level back in time to the first time it crossed that level, you will see that the underlying US economy was well below $10 trillion in size back then. Today, even with the recession of 2008-2009 and even with the obstacles that the government keeps throwing in its path, the economy is well over $14 trillion and very close to $15 trillion in size. This is an astonishing fact for investors to keep in mind.

However, these sorts of data do not make much impact on investors who believe that another huge recession is yawning ahead of them. To put those fears into perspective, we recommend they avail themselves of some of the historical and economic data discussed by Larry Kudlow in his most recent posting, "No Recession." We would also recommend our own posting from less than two months ago (when similar fears began to push their way to the forefront) entitled, "Do we have a dead economy walking?"

Finally, we would point investors to the most important point, which is our deeply-held conviction that trying to call economic ups and downs -- and trying to time one's equity ownership of promising companies to those economic forecasts -- is a loser's game, and a very dangerous one at that. We recommend that investors commit their financial market capital to well-run, growing businesses, and hold those investments through economic cycles. This ties their potential success to the quality of the business, rather than to their ability to make correct economic predictions (predictions that even professional economists botch quite frequently).

We would also point to previous posts we have written to try to pass along our convictions on these matters during previous times of panic, such as a post entitled "Don't Panic!" in 2010 here, and a series of posts entitled "Don't Get Off the Train" here and here.

Finally, we would note that corrections like this can be a good opportunity to contribute to investments which have long time horizons, if done as part of a plan of regular, disciplined contributions. For more on that subject, we recommend investors read "Paying yourself first," published on this blog on March 26, 2009. Those who followed its advice at that time had an opportunity to do very well indeed.