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Is This a Depression? For Markets, It May Not Matter

Call it whatever you like—recession or depression—the current economic state has investors concerned that a worst-case scenario is in the offing.

AP

Many think the word "depression" is, in fact, incidental to the real state of affairs. Things are bad, really bad, and everybody knows it.

"The closest thing we can find to the market collapse that we are experiencing now would really be '73-'74," says Peter J. Tanous, president and director of Lynx Investment Advisory in Washington, D.C. "The market went down over the two-year period 45 percent. I was already in the business 10 years in '73, and I can tell you this is far, far worse."

The dreaded "D" word has crept its way increasingly into public dialogue as both gross domestic product and the stock market have cratered since the beginning of 2009, beyond levels previously imagined by a large swath of analysts.

But unlike recession, there's really no technical definition for depression.

Just the use of the word, though, harkens back to the Great Depression that began with the stock market crash of 1929, and is sending shivers through the investing community.

"It becomes worrisome because so much of investing is based on confidence," says Quincy Krosby, chief investment strategist at The Hartford. "If you think that this tug of war going on now, that we are not going to pull out this, that any relief is temporary and that we will follow the pattern of depression, it's going to keep investors out of the market."

Forget, too, that the economic conditions are vastly different than during the Great Depression, which featured 25 percent unemployment and a string of double-digit drops in GDP. The worst the US has seen so far is 7.6 percent unemployment and the past quarter's GDP drop of 6.2 percent.

But investors have themselves worked into such a lather over the current downturn that perception is all that matters.

"I would classify this as a severe recession, but it's all semantics," says Tom Higgins, chief economist at Payden & Rygel in Los Angeles. "If we're talking about the events that we saw prior to 1929 or if we talk about 1907, we're just not there by orders of magnitude. This is a recession, it's a severe recession, but it's not a depression."

Higgins projects probably one more quarter of declines similar to the last quarter, then thinks GDP could turn slightly positive in the fourth quarter of 2009.

Not everyone agrees.

Some think the economy is headed for 10 percent productivity losses, though no one expects a repeat of Depression-era unemployment.

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"I think we rapidly and subtly have moved into a depression," Eric Hovde, CEO at Hovde Capital Advisers, said Tuesday on CNBC. "Given that you don't have any technical definition, it's hard to vehemently say one way or another, but I don't think there's any question that we have had over a 10 percent collapse in GDP." See Hovde's full comments in video.

As the debate rages, investment pros are coordinating their strategies.

Interestingly, Hovde thinks that even though the economy is at depression levels, the next move for stocks will be higher.

"We're slightly short," he said in describing his investment strategy. "I think we probably will see the next move be a move to the upside, and it could be a pretty good move to the upside given how fast things have collapsed."

Others are bracing for more damage ahead. Krosby is advocating stocks with low price-to-earnings ratios that can withstand the downturn, recession or not, while Tanous has continued to back stocks with high dividend yields, also with an eye not only to yield but also quality.

Like most of their peers, they're both concerned with investor perception of the market.

When President Obama on Tuesday advocated buying stocks, Krosby said traders snickered. Retail investors, meanwhile, look at the Dow Jones Industrial Average—traders focus more on the S&P 500—and see the continuing unrest over a lack of direction from the White House, she said.

"Psychologically it does feed on itself," Krosby says. "The Dow is Main Street's measure of their portfolios, of the mood of the country. It's almost a referendum on what the president's abilities are. You will hear people equate the two."

Art Cashin, director of floor operations, said he has felt the despair on the trading floor of the New York Stock Exchange, particularly after the Dow's 299-point fall Monday.

"I will tell you that the psychology of Monday's selloff was severe," Cashin told CNBC. "That gets up to the high despondency level and that usually tells me that we're getting ready. When they've given up all hope that's when hope is usually around the corner, and that was pretty close to giving up all hope."

"When you're in that oversold state you should have a bounce, and when you don't that's a very negative sign," Krosby adds. "It's telling you there is something far deeper going on."

So if it is a depression, bad psychology can only be overcome with good news, and that's been in scarce supply.

"We will at some point get a rally. All we need is one single bit of positive news that nobody expected," Tanous says. "We should not delude ourselves into thinking we are out of the woods, because we're not. We're still staring into the big black hole."