Odds Might Be Rising, But a Recession Is Still Far From a Sure Bet

By Jennifer Yousfi
Managing Editor

The U.S. unemployment rate for November rose 0.3% to reach 5% - the highest rate since 2003 - and non-farm payrolls gained slightly to 18,000, according to a statement from the Bureau of Labor Statistics (BLS). 

On Wednesday, the Institute for Supply Management (ISM) released the Purchasing Managers' Index (PMI) for December 2007. PMI fell to 47.7 in December, after 10 months of consecutive growth, signaling a slow down in manufacturing. PMI consists of five underlying indicators: new orders, inventory levels, production, supplier deliveries, and the employment environment.

These indicators are just the latest signs of an economic slowdown. A slumping housing market, rising energy costs, and the subprime-fueled credit crunch are all taking a toll.

"It's not a done deal, but if we're going to have a recession, it's too late to do anything about it,"' Stuart Schweitzer, global markets strategist at JPMorgan Chase & Co.'s (JPM)  Wealth & Asset Management unit in New York, told Bloomberg. "The Fed can't prevent a recession if one's in the making, and we're pretty close."

Due to the delay in release of economic data, it can be hard to pinpoint the beginning of a recession until months after its start. Some are certain the U.S. economy is already experiencing recession. 

"If I had to be bold, I'd say we began a recession in December," Bill Gross, manager of the PIMCO Total Return Fund (PTTAX), told the Financial Times in a recent interview.

Others seem inclined to wait for more data to be released before making a call. While it's clear the economy is slowing, it won't officially be in recession until it experiences two consecutive quarters of negative GDP growth. 

"Let's wait to see what January and February have in store, especially since BLS is notorious for revising the data. Anyone remember the negative August jobs report?" Joel Naroff, president and chief economist of Naroff Economic Advisors, included in a note to clients.

The August 2007 jobs report initially showed a loss of 4,000 jobs leading many to exclaim a recession was here. That number was later revised upward to a healthy gain of 89,000 by early October and the third quarter went on to post the highest GDP gain, 4.9%, in four years.

The Standard & Poor's 500 Index closed Friday at 1,411.63 - down 10% from its 52-week high of 1,576.09. And that could spell trouble, says Money Morning Investment Director Keith Fitz-Gerald.

"Should we fail to hold this level in the days ahead, the next stop down is 1329.26 which will be psychologically devastating to investors who are not using trailing stops or 'inverse funds' to profit from a decline," which Money Morning readers have been advised to do in a series of news stories and investment-research reports.

Statistically speaking, the markets have fallen both far enough and fast enough that they are pushing new downside limits, Fitz-Gerald says. And, strangely enough, that points to upside potential, since markets have posted a decline like the current one only about 10% of the time. Therefore, it's entirely logical to continue to plan for the upside, Fitz-Gerald says.

Potential upside triggers include a decline in oil prices, an interest-rate reduction by the U.S. central bank, or a federal fiscal stimulus package, Fitz-Gerald says.

How to Profit, Even During a Recession

Regardless of what happens here at home, Money Morning's Fitz-Gerald cautions investors to remember that even if the U.S. economy contracts [though it's more likely U.S. gross domestic product (GDP) will advance at a modest pace of 1% to 2% during 2008], the rest of the global economy will be doing quite well - with economic growth rates as high as 8% to 9%. With foreign economies growing that briskly, there will be plenty of profitable investment opportunities available.

Investors should turn their attention to U.S.-based multinationals with a substantial portion of sales coming from overseas as McDonald's Corp. (MCD) and Yum! Brands Inc. (YUM). And while they offer significant foreign-market exposure, being U.S. companies, corporations such as McDonald's, Yum! Brands and such others like The Coca-Cola Co. (KO) and PepsiCo Inc. (PEP) at the same time offer investors the transparency of U.S. financial reporting requirements and the relative protection of the U.S. investment-regulatory system.

If you prefer to invest more directly in foreign growth, Money Morning Contributing Editor Martin Hutchinson says to try South Korea's largest wireless service provider, SK Telecom Co. Ltd. (SKM). SK is well positioned to capitalize on the growing Asian markets. Likewise, the Hsinchu, Taiwan-based Taiwan Semiconductor Mfg. Co. Ltd. (TSM) [commonly referred to as TMSC], the world's largest dedicated semiconductor foundry, is another Asian tech company that is not currently overvalued and should do well in the New Year, Hutchinson says.

Traditional inflation-sensitive investments such as currencies and commodities are also good plays during a recession.

The PowerShares Agriculture Fund (DBA), operated by German giant Deutsche Bank AG (DB), is intended to reflect the performance of four commodities in the agriculture sector - soybeans (31.13%), wheat (28.87%), corn (23.43%) and sugar (16.58%). These include some of the key agricultural commodity plays that Jim Rogers advocates.

Another is Van Eck's recently launched Market Vectors Agribusiness Exchange-Traded Fund (MOO). Like the PowerShares Fund, this reflects the agriculture industry but in a different way. Instead, the ETF's holdings reflect returns seen from agriculture chemicals (34%), agri-product operations (33.5%), agriculture equipment (24.3%), livestock operations (5.6%) and ethanol/biodiesel (2.3%).

For investors who have the constitution of a Contrarian investor - as well as some patience and a long time horizon - it may be well worth a look at some of the beaten-down financial-sector stocks that state-run sovereign wealth funds are buying into in a wholesale manner.

Although many U.S. investors are preaching caution - if not total avoidance - when it comes to companies involved with the American financial-services sector, these government-run investment pools clearly view such stalwarts as Citigroup, UBS, Merrill Lynch & Co. Inc. (MER), and Morgan Stanley (MS), as bargain-basement investment opportunities. Fitz-Gerald favors Citigroup.

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