Experts look at ways to weather economic downturn

So is this what a recession looks like?

The Dow Jones industrial average and Standard & Poor's 500 are down about 15 percent from their October highs.

Economic indicators aren't looking too rosy either. Last week, it was reported that the state unemployment rate jumped from 4.4 percent in November to 4.9 percent in December. Home construction nationwide dipped to its lowest level in more than 16 years last month. The Twin Cities housing market has also felt the slowdown with lower prices and houses taking longer to sell.

President Bush on Friday proposed a $145 billion stimulus package of tax breaks to jump-start the economy.

While experts debate whether this is indeed a recession -- defined as two quarters in a row of declining economic growth -- investors are left to wonder: What's going to happen to my nest egg?

There's no consensus among Twin Cities investment professionals about the direction of the stock market or the fate of the economy, but they all have their strategies to deal with a downturn. Even the most bearish among them doesn't think the sky is falling, although it may feel that way because of a spate of bad news that rapidly propelled the U.S. equity market southward.

"It's a normal, cyclical bear market which comes around about every 4 1/2 years," said Steve Leuthold, chief investment officer of Leuthold Weeden Capital Management in Minneapolis. He reduced his stock exposure to 30 percent of his portfolio in late July in anticipation of a recession, which he believes started in the fourth quarter. Although, he noted, it's "not a terribly deep one." The rest was shifted to equity hedges, cash and fixed income. He figures the market will decline as much as 28 percent from its fall 2007 peak before starting its ascent mid-2008.

Keith Hembre, chief economist at Minneapolis-based First American Funds, agrees with Leuthold about the recession. He adds that when the recession ends, it won't much feel that way. "What makes the economy feel better to the person at large is the performance of the labor market," he said. But like the recovery after the two prior recessions, Hembre thinks employers will be slow to hire, and a poor job market could crimp consumer spending.

The declining housing market will hit consumers in their pocketbooks as well. "In order for the average household to maintain their level of wealth or well-being, they'll need to save more of their current income," said Hembre.

David Joy, chief market strategist for Ameriprise subsidiary RiverSource Investments, is not convinced consumers will rein in spending. "We are great at talking about how bad things are, but then we generally spend every penny we make." He forecast slower growth, but not a recession for 2008. Yet with each piece of negative economic news, he said, that assessment is getting harder for him to defend when talking to clients and Ameriprise advisers.

James Paulsen of Wells Capital Management said we've had a psychological recession for some time now. "And we've yet to have a quarter of growth less than 4 percent," he said. The chief investment strategist blames the panic on reports of financial firm write-offs with dollar amounts that "sound big to us" and the tendency to focus on a single weak monthly economic indicator such as unemployment or retail sales as a signal that economy is "going to heck."

Paulsen is expecting slower economic growth but is still figuring the economy grew 2.5 percent in the fourth quarter of 2007 and estimates first-quarter gross domestic product growth at about 2 percent.

Cash or emerging markets?

The temptation may be to follow pros like Leuthold and Hembre and cash out of your stock positions to stave off further losses. But Leuthold thinks that strategy was best executed last summer. The only selling Leuthold suggests today is unloading underperformers when the stock market has a 4 or 5 percent rally. "Probably the next best thing is to do nothing and ignore it," he said. And don't put any more money into the stock market. "We're five or six months away from a good buying opportunity," he said.

For individuals looking for ideas of which stocks may perform well in this environment, Leuthold's health care and biotech stocks have done well. First American Funds' Hembre thinks "a defensive tilt makes sense." Defensive stocks are categories whose performance isn't typically tied directly to the state of the economy. Think consumer staples like food, health care and utilities -- things in demand whether the economy is up or down.

Paulsen, on the other hand, thinks it is too late in the game to flock to defensive stocks. "They've been bid up in price relative to other stocks not because the fundamentals got better but because everyone thinks everyone else's fundamentals are going to get worse." He'd look at economically sensitive stocks-- retailers, technology, and industrials and materials (think Boeing or Alcoa). Of those, he thinks technology is attractively valued and that industrials will outperform if he's correct and net exports improve.

Paulsen would also avoid high-quality bonds. "I just do not see the attractiveness of buying a 10-year Treasury at a 3.68 percent yield in a 4 percent inflation world. To me, people are running there to avoid risk, but I think they might be running to the one place that's got the biggest risk for a couple of years." The risk? That the economy doesn't slow down much after all and interest rates rise. The Federal Reserve is expected to lower rates as much as 0.50 percent at the end of this month.

RiverSource's Joy likes short-duration bonds and corporate bonds. He also calls emerging markets "the most attractive equity markets in the world despite how much money has flowed into them and despite the returns they've delivered." But he wouldn't put more than a few percent in the asset class.

Financial planners are coping with this market with slight tweaks to the average client's portfolio depending on risk tolerance and time horizon. And the phones are not ringing off the hook with frightened investors. "I have a couple of clients who called and thought it was pretty funny to say, 'Move all my money to cash!'" said Shawn Jacobson, a certified financial planner with Legacy Financial Advisors in Bloomington and president of Minnesota's Financial Planning Association. But he hasn't received a single serious call asking him to move money to the sidelines.

Jackie Larson, a financial consultant with RBC Dain Rauscher in Minnetonka, says that, for her, proper asset allocation is the way to recession-proof a portfolio since the biggest risk for investors with a long-term horizon is getting scared and cashing out. The key is designing a portfolio around a client's risk tolerance. "That way you are able to stay the course whether that course is heading south for a little bit or starting to head back up."

Both Jacobson and Larson have made slight tweaks, buying large, fast-growing companies that tend to fare better in a slowdown. Both also sold stocks last year to bulk up on cash for clients in or near retirement so the clients could ride out a decline without touching their stock mutual funds or cutting back.

Clients with a longer time horizon, however, remain fully invested in stocks. "I do believe that ... if you put everything in the market today, that 18 months from now you would say 'Hey, I have a pretty decent return on this,'" Jacobson said.

Kara McGuire • 612-673-7293