Monday, Nov. 02, 1998
Recession? Not!
By James J. Cramer
Wall Street swings to extremes in a flash. For years portfolio managers have worried about the spectre of runaway inflation, as employment and incomes threatened to power into sixth gear. Now, after a summer of turbulence, they have become convinced that the economy won't weather the quick downshift. They are jettisoning the stocks and bonds of any companies that could stumble if the decade-old expansion turns to recession. But what happens if that severe slowdown doesn't hit? What if the Fed won't let it happen and moves aggressively to cut rates? Then Wall Street will have created the same sort of bargains that it does when it occasionally unloads drug stocks because of potential government regulation, or when it shuns tech stocks because a high-profile semiconductor or software company stumbles.
If you believe, as I do, that the Fed's second, mid-October rate cut signals a vigilance that will avert a recession, you'll find great value in the so-called cyclical stocks and in high-yield or "junk" bonds. I have avoided junk for years because too many weak companies were able to borrow at rates only slightly higher than those paid by the strongest debtors. Confidence in the economy ran so high that even companies with no hope of making a profit this decade could tap the markets cheaply. Junk-bond investors weren't getting paid enough for their risks.
But this summer's shake-out among hedge funds (big buyers of junk paper), coupled with a belief in an imminent recession, has widened the spread between high-yield and government bonds to extraordinary levels. Speculative bonds now yield almost double what you get on risk-free Treasury bonds--a remarkable opportunity.
Here you, the individual investor, have the edge on me, the professional money manager. Buying the high-yield bonds of individual companies, as I would have to do, would leave me vulnerable to the junk market's current illiquidity (expressed as the large gap between the price at which you can buy and sell the same bond). But you can buy shares in a diversified junk-bond mutual fund with a good record, such as Fidelity High Income or Vanguard High-Yield Corporate Portfolio. You'll get a high yield and the potential for capital gains when the market steadies.
In the equity market, the list of stocks posting new lows in their price has been littered with quality, brand-name cyclical companies--Case, Deere, Goodyear, Union Carbide, Whirlpool--which could rebound sharply if recession is averted. Quality commodity producers--Phelps Dodge, Reynolds Metals, U.S. Steel--sell at prices previously seen only during the harshest of downturns. If these stocks stay down too long, you can bet that larger companies will make takeover bids.
Investors usually look no further than their medicine chest or refrigerator for their long-term stock ideas. Sometimes, though, you have to look in your laundry room or garage. The value in today's market lies not in "defensive" names--the Mercks and the Proctor & Gambles, which are priced dearly on recession fears--but rather in stocks and bonds of companies that need a strong economy to push them higher. Wall Street's newfound pessimism could give you a chance to buy these normally "risky" instruments at prices at which the risk is more than amply compensated and nothing lies ahead but reward.
Cramer runs a hedge fund and writes daily for thestreet.com His column should not be construed as advice to buy or sell stocks.