Is America in a recession? Is inflation the big issue? Is housing bottoming? Here’s a big Wall Street secret: No one knows.

There are people lined up on both sides of these and other earthshaking questions, all of whom have excellent credentials, convincing full-color charts, and usually one or two top-notch football metaphors. The truth, however, is that investors are rarely served by trying to answer the Big Questions of the day.

Instead, it’s wise to rely on history, common sense, and a few helpful hints from successful investors who have been through similar
periods.

The chief investment officer for Northern Trust, Orie Dudley, has been around the block a few times and consequently takes a reasoned approach to the current economic uncertainty. In his most recent letter to clients, he reminds that it is when people are most frightened that the best opportunities present themselves. That is why stocks typically do well during recessions. In fact, Mr. Dudley points out that the S&P 500 has gained 10% on average during the last nine recessions.

He says he thinks that there are numerous reasons to look at stocks today. One is that “progress is being made in dealing with the housing cycle,” which has been in decline for three years and is finally nearing its nadir. A second is that liquidity issues will recede as rates drop. A third reason to look at stocks is that the rise in oil prices is a constraint to growth, but he points out that the increase is tempered by long-term conservation efforts. “Developed countries … use less than half as much oil for each dollar of gross domestic product than they did in the 1970s,” he writes.

Other reasons for optimism include sound balance sheets and inventories in the corporate sector (excluding financials) and the investment opportunities offered by sovereign wealth funds.

Sorrell Mathes, head of an eponymous investment firm, brought in returns twice those of the S&P 500 last year. His success was largely due to avoidance of land mines, especially in the fourth quarter, when he raised significant amounts of cash. Mr. Mathes is not expecting a recession, but is quite concerned that slowing growth will continue for a while, and chooses not to fight the tape. In recent months, he has been reallocating his portfolio away from industrials and financials, raising cash, and plowing some proceeds into consumer staples and technology. He admits to having been overly optimistic about the housing correction leaking into the overall business outlook (he didn’t expect such contagion), but is now adjusting portfolios to weather whatever downturn is in store.

Consumer staples also attract the attention of James Steiner, head of Lowry Hill, a $7 billion investment group out of Minneapolis. He cautions clients not to chase after “expensive global commodities and cyclical industries,” as they are operating at “peak margins,” or “speculative technology shares,” which are selling at peak multiples.

His preference is for franchises such as Johnson & Johnson, a “strong and stable company in a steady industry.” Mr. Steiner reminds us that J&J saw its earnings increase by 116% between 2001 and 2007, while its stock price rose by only 13%. That’s a compelling shrinkage in valuation.

What do the three experts have in common? They are expecting the economy to more or less perform as it has in the past, responding to fiscal and monetary stimuli in a fairly predictable fashion. The depth of the slowdown and the timing of a rebound are unclear, but history suggests that night will continue to follow day.

If this seems a bit boring, there are other ways to make money in these turbulent times that do not require knowing precisely what the economy or the stock market is going to do. One investor touted recently the advantages of buy-writes, a strategy that many professional traders use to increase returns in down markets. The term “buy-writes” means essentially the same thing as writing covered calls. Studies have shown that the strategy can reduce volatility and improve returns.

Here’s how it works: Let’s say you agreed with Mr. Steiner that big consumer companies are undervalued, and bought Coca-Cola a year ago at $48. The stock traded up nicely, and earlier this year hit $65. You didn’t sell, being a long-term investor, and so have been sad to see it fall off to around $59, where it is selling today. You think the market is more likely to go down than up, and that this company is unlikely in the next few months to trade above $65. You can sell a May call at $65 on KO today for $1.05, which is yours to keep.

The downside is that if the stock rises above the strike price, you will be forced to relinquish the shares. If the stock stays where it is, you’ve picked up a 1.8% return in a little more than three months, which equates to about 7% incremental return annualized. If the stock trades in a narrow pattern for the balance of the year, you can continue to write calls and improve your returns. These are of course short-term returns; investors have to be mindful that they will be taxed at the higher rates that apply to ordinary income.

There are also closed-end funds that mimic indices replicating the buy-write strategy for the S&P (BXM) or for the Dow Jones industrial index (BXD). These provide investors with diversification and may be an easier way to go.

Overall, investors should have some confidence that though this cycle will be unique, it is not unprecedented. One very successful money manager passed along this the other day: People always sound smarter being bearish, but they make more money over time being bullish. Words to live by.

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