Is It Time To Prepare For Economic Weakness?

By: Chris Ciovacco | Wed, Jul 19, 2006
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Editor's note: Chris Ciovacco's seven part series will resume shortly.

Executive Summary:

Using investments from several different asset classes, investors can do very well even in bad times for the major U.S. stock indices and the economy. As described below, the odds now heavily favor continued slowing of the economy and lower stock prices in the next 60 to 90 days (maybe longer). Since the markets are now trending lower, it is prudent to revisit how several asset classes behaved during the last serious economic slowdown. The major U.S. stock indices began their last sustained period of losses in early March of 2000. This downtrend lasted until early October 2002.

Knowledge of the performance of several asset classes from March 10, 2000 to October 10, 2002 can help investors prepare for the next economic slowdown. As many investors know, 2000 to 2002 was an extremely difficult time to invest. Below are some helpful stats showing index returns or returns for specific mutual funds. Mutual funds (names not shown) are used as a proxy for an asset class:

Returns Mar 10, 2000 to Oct 10, 2002
Index or Proxy Change
NASDAQ -76.9%
S&P 500 -42.4%
DOW -24.1%
Gold Bugs Index 66.5%
CRB Index (Commodities) 5.13%
Hedged U.S. Stock Fund 39.97%
Inter'l Real Estate Fund 7.4%
Long-Term U.S. Gov Bond Fund 40.4%
Short-Term U.S. Gov Bond Fund 39.3%
CBOE Gold Index 26.5%

Just as many of the asset classes above performed very well during the last bear market, there will be asset classes that perform very well during any future bearish periods. As we move forward, the performance from previous difficult times can be used as a guide to help investors allocate their assets during any future market weakness. Since many factors have changed since the period from March 2000 to October of 2002, investors cannot blindly use the correlations from that period today.

While investments should be made based on what is actually happening, it is helpful to put the past correlations in the context of the current environment.

What are the markets and economic indicators telling us?

Many market watchers have been calling for economic weakness for well over a year now. Based on experience, it is important to wait for the market to confirm any forecast (positive or negative) rather than try to guess or time when the current trend may change. As an example, many money managers have missed substantial gains in the last 18 months while they based their allocations solely on opinions or forecasts while ignoring the current market trend.

The NASDAQ still tends to lead other markets higher and it also tends to lead the way on the downside. The NASDAQ may now be confirming that the economy is headed for a serious soft patch or even a recession. After the bust, which began in March of 2000, the NASDAQ finally found a bottom in October of 2002. Since that time, the trend has been up. Based on recent declines, the uptrend may now be broken, which is a signal to prepare for possible further declines in all the major averages. The broken trend in the NASDAQ is easy to see on the chart below:

NASDAQ Breaks Trend
SOURCE: Chart from Yahoo! Finance

Since the markets seem to be confirming the negative forecasts, it is prudent to review some relationships between stocks, the Federal Funds Rate, the yield curve, and leading economic indicators (LEIs). Here are some bits of information that seem to be lining up with the recent poor performance in the major stock averages:

With recent market weakness, seasonal factors, and economic indicators all lining up in the bearish camp, it is prudent to review history and your current asset allocation.

The comments in this article are based on market activity as of Tuesday, July 18, 2006 at noon EDT and are subject to change based on future market activity.



Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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