Meet the Street: A New Kind of Recovery

This isn't going to be your father's economic recovery, says H. Vernon Winters.

That's because this recovery won't be led by increased consumer or corporate spending, as has been the case in most past recoveries, says Winters, the chief investment officer for Mellon Private Wealth Management, which manages $50 billion in assets for high net worth individuals. Instead, the exhaustion of retail inventories will be what revives the economy.

Winters further says the economy may have bottomed out, but that the "shallow recession" the U.S. is in likely will last at least a few more months. And it will be quite some time before corporate spending regains momentum, he says. As for consumer spending, it's been strong and, Winters believes, should continue to be.

Winters is advising his clients to look to high-yield bond funds, small- and mid-cap stocks and international equities. Here's his take on what investors would be wise to do.

TSC: Over the past 20 months, time and again, investors have been hearing how a recovery is just around the corner. What do you foresee for the year 2002 that investors can really count on at this point?

H. Vernon Winters Chief Investment Officer, Private Wealth Management, Mellon

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Winters: Absent Sept. 11, conditions in the economy were mild enough that we may not have had a recession at all. The market, as you will remember, was hitting a low in the late March/early April time frame; that very well may have been the low in the market, had Sept. 11 not happened.

The people who were speaking early last year about an improving economy and a bottoming-out market situation might have been correct on that, absent Sept. 11. The whole thing got postponed because of that, it seems to me. And now we are, perhaps, seeing at least some signs of a bottoming in the economy.

I think there is going to be weakness into early next year -- but the market has always anticipated the end of a recession and seems to have done so again this time. Once a recovery is under way, generally, there are some legs to it. And I suspect we will see this, as well, this year.

TSC: What are you telling your clients to do with their money right now?

Winters: Our clients have typically had a very large core of their portfolio in large-cap stocks, and over the last couple of years we've been suggesting they diversify more into smaller- and mid-caps. That's been a successful recommendation.

We continue to believe that small- and mid-caps offer more value and more potential return as we look out over the next year or so. We don't think it's too late to continue to move funds out of large-cap and into small- and mid-[caps]. We think the valuations are superior there. Small-caps act very much like cyclical stocks in that their earnings get hurt more in economic downturns; that's been the case this time, and we expect their earnings' recovery potential to improve as the economy improves as well.

We also think it's going to be a year of a recovering economy, and we think the snapback could be pretty decent because of inventory corrections. We could have a pretty good snap in the economy, and then it will moderate.

Of the several reasons for that, the consumer usually leads us out of recession and provides a lot of spending for the economy. And the consumer this time has maintained ... spending on automobiles and homes. This year [2002] likely will be the second strongest on record for home sales.

TSC: What about corporate spending, then? Will that be what leads us out of this mess?

Winters: This downturn was led by a collapse in investment spending, and with capital utilization and profitability as hurt as it has been in this downturn, we have a hard time seeing capital spending leading a revival in the economy. So we think it will be a pretty modest upturn, and stocks are going to reflect that. And we have been trying to condition clients to expect much more modest returns, not just for this year but also for the next several years, than we have been used to.

TSC: What projections are you giving clients for the GDP and the major indices, if any?

Winters: We don't make those projections, but I will say that in this environment, broader diversification makes a lot of sense. Think about it: You could go back to the beginning of the long-term secular market in 1982. All you really needed to do was [invest in] large-cap and long bonds. That was a marvelous strategy. But I think both of those have peaked out in terms of the relative performance they are going to deliver. You need to diversify.

Small- and mid-cap are one way of doing that. I think international investments, though, are also going to [have some strong returns] compared to the U.S., if you look out to the much more modest downturn that they experienced in Europe. Even Japan, which has been a drag on everything, is likely to turn around. There is very little downside left in Japan.

As well, we think the large spreads on high-yield bonds provide an excellent reason for investment, and we are recommending these instruments to our investors as an alternative in the equity portion, not the fixed-income portion, of their portfolios.

TSC: And consumer spending? Do you expect it to continue to hold up in light of all of the continuing layoffs, even at the successful companies, which now seem to be jumping on the layoff bandwagon?

Winters: Yes. Consumers will continue to spend. Consumers, in general, are continuing to make more money.