“This Time It’s Different”

Jonathan Burton for MarketWatch recently posted a feature about the 4 most dangerous words in the vernacular of investing. Specifically… "This time it’s different."

As Burton explains it, the late 90s/early 2000s tech bubble is a prime example. Stock market valuations no longer mattered… it was a new era of dot-com excitement and endless possibility. Of course, it wasn’t a new era and the stock market suffered one of the worst bears in its history from 2000-2002.

Real estate’s collapse is another. "This time it’s different" led to the perfect storm of imprudent lending standards, get-rich quick home flipping and faulty declarations of ever-increasing demand amid limited  supply. It wasn’t a new era for real estate either… as the 2007-2009 real estate crash continues.

Some say that energy and commodities may be the next to falter… if they haven’t already; that is, you’ve got alarmist projections about demand for all commodities far outstripping supply, crippling consuming nations and causing greater geopolitical tensions. It’s not that commodities haven’t been hot, but "this time it’s different" has led some to over-allocate to energy/resources at a time when demand could possibly slow.

Yet "this time it’s different" thinking can be harmful in a different sense. Just as extreme optimism leads to an inability to see impending doom, extreme pessimism is going to keep investors from making wise purchasing decisions for long-term wealth.

If you read the mainstream media with any degree of regularity, you can’t help but feel that the U.S. economy is lost forever. Our dollar is on its way to being worthless. Our system of credit will never operate smoothly again. And Wall Street will be mired in a bearish grip for many years to come.

Why? Because this time it’s different. Recovery for the investment markets? Impossible… because this time it’s different.

Hogwash!

History shows that the mid-point of a recession typically marks a stock market bottom. In other words, new bull markets begin when things couldn’t possibly seem any worse. Just as they did in October 2002… or March 2003… depending on who’s calculating.

The 2nd half of a recession and the 1st half of an expansion, then, collectively represent "the opportunity." And there’s nothing different about that historical note since 1802. 

It follows that the challenge facing investors today is to feel reasonably confident that we’re halfway through a broad market downturn. (As an aside, if you believe that we are halfway through the credit crisis, similar logic would suggest that financials, albeit very volatile, present an attractive opportunity for incremental purchasing.)

Here’s how I am hoping to identify the recession’s mid-point. In the initial stages of economic contraction, smaller businesses struggle more than larger businesses. This would be reflected in small business share prices of ETFs like the iShares MicroCap Fund (IWC).

Indeed, this is precisely the case. Since the October 2007 highs, IWC has trailed the large companies in the S&P 500 SPDR Trust (SPY). However, when these paths intersect for the first time since October 9, 2007, I would be inclined to see that as an initial sign that economic contraction is half-way through. And for glass-half full investors, that time would effectively mark a potential incremental purchasing opportunity into early business cycle leaders like tech and financials.

The chart (left) shows that we haven’t quite hit the mid-point of our slow growth/stagflating economy. That said, this is a barometer that I will be keeping my eyes on. After all, this time it’s not any different.

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