The markets have played the role of ugly duckling so far in 2008.  The Fed’s statement last week that they would take swift action to prevent further economic weakness suggests that the economy may be more fragile than they had previously expected.  The Fed will likely cut by 50 basis points at their month end meeting, if not earlier.  

Earnings season starts in earnest this week and we should catch a glimpse into whether or not the difficult macroeconomic data is translating directly to weakness at the company specific level.  This morning, IBM announced results that were substantially ahead of expectations, suggesting that the weak dollar has definitely boosted exports and also proving that a lower dollar doesn’t always have to be viewed in a negative light.  On the other hand, Tiffany’s stock came under pressure on Friday following weaker guidance, suggesting that consumer spending — even at the high end — might be under pressure.    

In spite of the negative tone to the year, this isn’t a time to panic.  The markets are clearly discounting a greater probability of recession.  If we fail to actually get one, the upside gains from here could be significant.  Don Hays, a respected investment strategist, recently noted that the last time the markets got off to such a poor start in January, they actually closed up 40% for the full year.  On the other hand, if we are in a recession, there may be additional downside, but we may already be halfway there given what we’ve experienced thus far.

To be sure, the economy won’t turn overnight.  Like a skilled doctor, the Fed can help set things in the right direction, but nothing heals quite like time does.  For growth investors, this is just what the doctor ordered.  A period of prolonged slower economic growth would extend the period of relative outperformance for growth stocks. 

Sometimes ugly ducklings do turn into beautiful swans.