A prominent investment strategist argues that the downturn is over for stocks -- and that the economy will avoid a recession. By Steven Goldberg, Contributing Columnist April 1, 2008 Is James Paulsen crazy, or is he crazy like a fox? One thing for sure: The chief investment strategist for Wells Capital Management isn't afraid to go against the crowd and the conventional wisdom. If he's right, the worst is over for the stock market.To start with, Paulsen, an economist, believes the U.S. will avoid a recession -- a view at odds with that of most economists, who think the U.S. is already in recession. He thinks we're in "a mid-cycle correction" -- that is, a temporary slowing of growth, but not a contraction of the economy. He thinks we're going through a "fearsession" rather than a recession. "Every crisis is partly fundamental problems and partly fear," he says. "This one seems to be more fear than it is fundamental issues. The ratio of hollering and hand-wringing is far beyond reality." The problems are centered on Wall Street -- and most of these, Paulsen argues, result from pure panic. "Bear Stearns went under for no fundamental reason," he contends. In other words, it was mainly fear that caused others on Wall Street to lose faith in Bear Stearns -- not problems so severe that Bear had to practically give itself away to avoid extinction. Advertisement With sentiment so negative, Paulsen says, there's every reason to believe the stock-market's selloff is finished. Investors have plenty of "dry powder" to invest in the form of money-market funds and other cash equivalents. Meanwhile, the Federal Reserve is "firing every policy gun known to man" to forestall a market or economic collapse, says Paulsen. The economy is healthier than you'd think from reading the headlines. Outside of housing and autos, which make up just 7% of the nation's gross domestic product, the economy is growing at a 4% annual clip, Paulsen says. If those two sectors can just slow their rate of decline, and he believes they will soon, the economy will recover its footing quickly. Nonfinancial corporations have healthier balance sheets than at anytime since the 1960s, Paulsen adds. Unemployment remains relatively low. Meanwhile, stocks are cheap based on price-earnings ratios, and even cheaper when matched up against the paltry yields offered by Treasury securities. Advertisement Paulsen doesn't minimize the housing decline, but he's skeptical about how badly it will impact the rest of the economy. Even if housing prices drop a total of 20% -- and we're about halfway there already -- relatively few people will be severely affected, says Paulsen. That's because housing prices soared before beginning the current decline. Most of those who lose their houses will be those who bought late in the game with subprime mortgages, Paulsen says. They'll go back to renting, and they'll be little worse off than they were. After all, they invested little or nothing into their houses. Finally, financial crises don't necessarily end in full-fledged bear markets or deep recessions. For instance, there was no recession either before or after the 1987 stock-market crash. The 1990 savings and loan collapse touched off only a mild recession and a short bear market. The U.S. weathered the 1998 Asian contagion without a recession or a bear market. And the recession that coincided with the devastating 2000-2002 bear market was mild and lasted a relatively brief eight months. What to buy? Paulsen says it's too late to invest in obvious defensive stocks, such as consumer staples. They've already been bid up in price. Instead, he encourages investors to load up on stocks in more economically sensitive areas. His favorite sectors are technology, industrials, materials and consumer-discretionary stocks -- sectors that have been hard hit in the selloff. Advertisement He also expects the dollar to bounce back this year-and for that to help bring down overheated energy prices. He likes U.S. stocks and Japanese stocks over European stocks. And he's a big fan of emerging markets. Could Paulsen be right? Perhaps, although I still think there's worse to come for the stock market. Nevertheless, bear markets are a terrific time to buy stocks at depressed prices. And, if Paulsen's forecast is correct, you'll be making money in short order. Steven T. Goldberg (bio) is an investment adviser and freelance writer.