Sunday, January 20, 2008

what is a recession?

what is a recession, and what does it mean for stocks?
The answers may surprise you....

What goes up must come down.
A recession is the period between a peak of economic activity and a trough. Recessions typically last between six and 18 months, and they're a perfectly natural part of the business cycle. A recession does not mean that economic growth has stopped, it merely means that it has slowed down.

To determine whether the economy is in recession, the National Bureau of Economic Research (NBER) analyzes changes in factors such as gross domestic product, personal income, employment, industrial production, and retail sales volume. There is no fixed rule for how the different indicators are weighed.

It takes time for the NBER to collect and analyze this economic data. By the time it's determined that the country is in a recession, odds are that the economy is already close to recovering.

Stocks can also go up in a recession?
Since 1945, there have been 11 recessions lasting an average of 10 months each. But according to a recent article from Hulbert, during these recessions, the stock market actually rose seven times and the average market return during all 11 recessions was 3%!

Meanwhile, quality companies with strong balance sheets, solid free cash flow, and shareholder-friendly management actually prospered during this period.

A drop in the markets can be frightening, but it shouldn't make you sell. You buy a stock, it's because you think that the stock is worth more than its current price. If the stock falls, but nothing else has changed, then it has become a better deal because it's cheaper. So you should be thinking about buying, not selling, at times like these.

Successful value investors like Warren Buffett act this way. He doesn't panic and dump shares when the market falls, but rather looks upon the drop as a buying opportunity.

Concentrate on finding the types of stocks that will perform well in any economic environment.

Excerpts are derived from and edited to suit local needs.
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