In last week's DailyWealth, Steve Sjuggerud published compelling research suggesting the worst is past and there's another bubble coming. The Federal Reserve is the reason. We've never before seen recessions when the Federal Reserve is in "accommodating" mode and interest rates are at zero.
"The recession is most certainly over," he wrote. "In fact, the more likely scenario is a boom."
I hate to take the opposite side of a trade from Steve. He has an uncanny ability to always be right. But I'm not convinced the recession is over. My reason is simple: The Fed's usual policies are not working any more.
I found this last week...
"Lending falls at epic pace," screamed the front-page headline of the February 24 issue of the Wall Street Journal.
It seems America's banking system is so troubled by losses on commercial and residential real estate loans, it's refusing to lend more money. And the economy is so grim no one wants to borrow money anyway. So the number of loans outstanding in the banking system is declining.
In 2009, U.S. banks registered their largest full-year decline in loans outstanding in 67 years, according to the Journal. The worst carnage happened in the final quarter of 2009. In the final quarter, banks wrote down $53 billion in loans, the highest write-off rate since the FDIC began collecting data 26 years ago.
When credit contracts and the market forces bankers to write down loans, you get hundreds of bank failures.
Three banks failed in 2007. Twenty-five banks failed in 2008. One hundred and forty banks failed in 2009. Fifteen have failed already this year, and the FDIC says hundreds more will fail soon.
The FDIC is the government branch charged with insuring banking deposits and seizing failed banks. It maintains a secret list of problem banks. To prevent panic, it won't name the banks on the list. But it does publish the size of the list. Right now, there are 702 banks on it... a 16-year high.
(Few people know this, but the reason most of these banks haven't failed already is the FDIC lacks the staff and the money to seize them right now.)
In short, I believe America reached the limits of indebtedness in 2007, and no matter what the Fed does, it can't stop the forces of thrift. America is saving more, spending less, and borrowing less. While these conditions persist, there's no way the recession disappears.
In other words, we're in a once-in-a-century debt deflation and the Fed's interest rate policy can't stop it.
As Richard Russell, one of my favorite newsletter writers puts it, "There's a hard rain a' coming."
In light of this situation, cash should form the bulk of your investments. Don't worry about interest. You'll be so busy snapping up ridiculous bargains at the bottom of the shakeout, you won't care about a couple of years without interest. Cash should be invested in T-bills or T-bill mutual funds. You shouldn't trust your bank to remain solvent or the FDIC to insure your deposits. Keep a little under your mattress and a little in the bank for your day-to-day needs.
As for stocks, buy businesses that are loaded with cash and generate massive amounts of additional cash each year. To do this, they must have recession-resistant business models and minimal debt. These businesses will pay you dividends while everyone else is starving for cash. These dividends will feel extremely valuable.
I like Wal-Mart (NYSE: WMT, Stock Forum) and McDonald's (NYSE: MCD, Stock Forum). They check all my boxes and their stock prices both rose during the Great Bear Market of 2008.
The beauty of this approach is, if I'm wrong and Steve is right about the recession being over and another boom coming, these two stocks will still keep generating cash and paying larger dividends each year. Heads you win, tails you win, too.