Posted by Gregg Smith at February 4th, 2009

My wife enjoys the look of English gardens so she likes to grow vines on fences, the house, trees, other vines, and anything else that stays still long enough. You don’t want to take a nap in her garden. She will tell you I prefer a little more separation, which requires regular pruning.  Growing without control or limits, items lose their identity and the yard and garden look like a smoothing curtain of kudzu.

The S&P Index was down 37.5% last year.  As painful as that has been for many investors, our economic system was in serious need of some pruning.  Much of the growth which supported the higher values was nourished by loose lending and excessive debt.  When problems were finally discovered, instruments and institutions were so entangled it will take years to separate much of the garden from the vines.

Generally, I think TV economists are useful as entertainment only.  Their predictions are worthless because the endless complications of our economy make cloud pictures seem stable. This situation is different.  We do not have to know what the scenery will be like over the hill, but we do know the condition of our engine, and some of the cylinders are not firing.

As spending shrinks, the consumer will not be able to support duplicate businesses such as Linens and Things and Bed Bath and Beyond.  We will not need a Best Buy and a Circuit City. For a while, there will be fewer companies and less employees, excess store space, and lower revenues to the government.  With this reduced universe, we cannot expect the stock market to regain its previous value until the economy has had time to recuperate-not for months, for years. This is not a cynical position; it is reality which offers great opportunity to some investors.

The last century saw two periods in which the market stayed in a trading range for decades before corporate earnings became strong enough to support new ground.  Conditions now indicate that we have been in such a period since 2000 and it could continue for five to seven more years.

That does not mean market investors will wait that long for profits, but it does mean active management will allow the investor many opportunities to make and take profits while the inactive investor watches the pot that doesn’t boil.