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Mild Recession Could Present Opportunities

The government injected a dash of somber reality into speculation about bigger-than-ever leveraged buyouts last week. On Wednesday, it reported that the economy grew more slowly than expected in the July-September quarter and capital spending by business was disappointing. On Thursday, it said consumer spending in September was flat.

To be sure, there was a bright side to the news and a promise of long-term investment opportunity. But in the context of a single week, things looked bleak.

Financial markets saw the Federal Reserve reining in the money supply to nudge interest rates up and currency traders sending the dollar down--a fact that sooner or later may force the Fed to boost interest rates further and slow an already slowing economy.

Many people in the investment world were alarmed as the corporate bond market just about stopped functioning because of worries that LBOs and “junk bonds” would undermine the security of all bonds. Eastman Kodak, one of the nation’s most prominent firms, had trouble finding investors for a new bond issue last week.

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And an attempt by Federated Department Stores to arrange junk bond financing for its recent buyout by Campeau Corp. of Canada was turned away by the market.

The market’s fragility worries veteran analysts. “There are no buyers,” commented Charles Eaton III, portfolio strategist for Nikko Securities. “It’s scary.”

It was scary because many financial people saw the week’s events as signaling the beginning of recession--although few were ready to say the dreaded word.

But if consumers are cutting their spending, a lot of business surely will slow down. From housing to automobiles and from retail stores to amusement parks, there would be lower cash flows--and companies, particularly those that have undergone leveraged buyouts, would have trouble paying interest and principal on their loans. No wonder financial markets are nervous.

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Could Shift Priorities

However, there are balancing factors. The economy is slowing because it’s changing, not collapsing. There may be a mild recession as it makes the transition from a dependence on consumer spending--which now accounts for 66% of U.S. economic activity--to a greater emphasis on industrial production and sales to world markets.

Also there could be healthy reordering of priorities if Americans shift from spending to saving. One bright spot in the government reports last week was that personal savings rose in September.

And reordered priorities might well extend worldwide. A shrinking of U.S. imports--and the trade deficit--would lead to an international slowdown as the U.S. engine stalled. There would be pain, of course, but say this for recessions: They wash out speculative excess from financial markets. By one estimate, there is up to $200 billion in surplus capital now sloshing around in the financial markets of the developed world--speculating (and funding LBOs) when it might be more usefully invested in other projects at home or developing countries abroad.

And a purge of speculation might even bring the individual investor back to the stock market, which, historically and still, is the source of his or her greatest opportunity. You could look that up.

Ibbotson Associates of Chicago publishes annually the updated results of a study by Roger Ibbotson, a professor at Yale, and Rex Sinquefield, an investment adviser in Santa Monica, who compared investments in common stocks, bonds and Treasury bills--adjusted for inflation--over a period going back to 1925. The conclusions were dramatic: Common stocks gave a total return, including reinvested dividends, of 6.6% compounded annually from 1926 to 1987.

Nothing else was close. Long-term government bonds returned 1.2% adjusted for inflation, and Treasury bills returned 0.4%.

In dollar terms, says the study, $1 invested in common stocks in 1925 would be worth $347.96 today--while $1 invested in government bonds would be $13.35.

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What’s the message? If a recession comes, don’t rush to sell stocks; rather think of buying--on the other side of this slowdown lies a strong economy.


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