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Tuesday, 30 March 2010

More "Boom and Bust" Cycles Coming: The Real Reason Buy and Hold Is Dead

With major averages flat or slightly negative for the past 10 years, many investors have given up on the "buy and hold" strategy that became a mantra in the 1990s. That, of course, has prompted some contrarians to declare that now is the best time to be a buy and hold investor.

In this case, the conventional wisdom is right, says Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI).

"I'm not saying 'buy and hold' is a bad thing, unless you're having more frequent recessions," he says. And that is precisely what ECRI expects in the coming decade because of two big patterns that Achuthan says are irreversible:

* One, sucessive recoveries from post WWII recessions have become weaker and weaker "on every count," including growth, sales, employment and production.
* Two, there's more volatility in the economy, with the big swoon in late 2008-early 2009 and surge in more recent months being a glaring example.

Achuthan predicts we have entered a period of "more ‘boom and bust'-type cycles," similar to what occurred in the 1970s. "The Great Moderation is history," he says, referring to the period starting in the mid-1990s when many economists (and policymakers like Ben Bernanke) believed the business cycle had been smoothed out, if not eradicated.

"You don't have to be a mad scientist," he says; just "back off your risk in the stock market and buy bonds" if a recession appears imminent. "And if we see a recovery take more exposure and get out of bonds because the recovery is going to give you a little inflation."

If recessions are more likely - and more intense in scope - then investors will demand higher risk premiums for owning equities, Achuthan explains in the accompanying clip.

Of course, the trick is predicting when those recessions and recoveries have begun -- or are about to begin -- something ECRI believes it has mastered. As noted here, the ECRI does have a good track record when it comes to predicting economic cycles. They correctly predicted last year's strong recovery after having correctly called the 2001 and 1990 recessions. However, ECRI waited until March 2008 to officially diagnose the last recession that they now agree began in December 2007.

"I'm not suggesting we'll get it right all the time but we'll do a lot better than ‘buy and hold,'" Achuthan says.

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