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Friday, February 29, 2008

Rationally Ignorant Investors

Currently, unless you are totally disconnected from all sources of news, it is impossible to go a day without hearing some talk about a looming economic recession. The credit crunch and mortgage crisis, no doubt, have had a profound effect on the economy, but are things really as bad as they seem?

In reality, the answer to that question is…maybe. It is way too early to tell if a recession has appeared. In fact, it takes two, consecutive, quarters of negative GDP for a recession to be officially declared. In the fourth quarter of 2007, GDP grew (albeit a very small amount). Then, we have President Bush and Ben Bernanke saying that we will not endure a recession, just slow growth. So far, they have been right. However, every time the stock market goes down, more talk of recession surfaces. The first three days of this week saw stock prices go up a decent amount. However, disappointing news today, from a few major companies, caused investor fear to skyrocket, sending all three major exchanges down over 2% each.

It seems as though any slight sign of economic distress causes investors to dump shares like no other. Let us consider the case of NutriSystem (NasdaqGS: NTRI). This is a company that has experienced significant growth over the past few years. They are a cash-rich, debt-free company, and should be able to weather a recession. When they reported fourth quarter 2007 earnings, they actually earned .04/share more than Wall Street analysts expected. However, they said that they may not experience the same level of growth they had in the past few years due to increased competition, and the possibility of economic hardship. Their stock price fell over 30% in two days. To me, this seems totally ridiculous. I mean…DUH! What company will experience rapid growth during a recession (growth defeats the whole point of a recession)? If the company is profitable, and debt free, all of this panic is unwarranted. If all of the recession “hype” was not around, NutriSystem’s stock price definitely would not have taken this massive a hit. All of the talk about the recession is making investors rationally ignorant with respect to the facts of the companies they own stock in. They simply see recession in the news, and dump any stock that has less-than-stellar news.

The sad about this whole situation is that no matter what policy makers, such as Bush and Bernanke, do they cannot simply make the recession rumors stop. As they keep on lowering interest rates (or announcing tax rebates, for that matter), in order to boost the economy, all they are really doing it temporarily sustaining it until more bad news comes out of the market, and reducing the value of the dollar.

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