December 01 2009 | Filed Under Commodities , Economics , Economy , Investing
Basics , Options , Recession , Stocks
People will always question what the future economy will look like after it
suffers a recession. Though there are different implications with each
recession - owing to its causes and the governmental and financial changes that
are brought about - the economy will definitely shift and there will emerge new
economic practices and trends for industries, consumers and investors.
Following the depths of the 2007-2009 recession there's a "new world"
characterized by:
Non-existent consumer discretionary spending
Tighter credit and borrowing standards
Reduced home ownership
Increased consumer savings
The above effects will serve to:
Hold down corporate profit growth
Restrict employment growth
Likely reduce future expected market returns
Despite the above, investors have options and opportunities as long as they
keep their expectations in line with the expected future outcome. Some
wonderful investment opportunities exist for investors in all stages of life.
Industries to Look For
When it comes to investing in the economy defined by the characteristics above,
one question should dominate your investment consideration: Does this company
make an essential or non-essential product?
When times are tough, people respond with their wallets. Unless folks are given
great incentives, they won't buy unless they have to. In that kind of
environment, I would favor food companies to retailers, healthcare providers to
homebuilders, and defense contractors to automakers. Things like food, medicine
and national security are musts in this world. An extra purse or a new car or
bigger homes are not. And here's the best part: most of the companies that
provide these necessary goods will continue to be around for a long time.
(These type of companies are normally grouped in a sector called consumer
staples to learn more see A Guide To Consumer Staples.)
When economies are sour, the stock market tends to punish all companies
regardless of what line of business they are in. In other words, a business
like a Kraft or Johnson and Johnson that sell essential food and health
products all over the world may likely see its shares suffer along with other
discretionary businesses like retailers. And you can be comforted by the fact
that even in tough times, people still need to buy food and Tylenol. Looking
for these types of companies will likely earn you market-beating returns during
the several years following a recession, despite an overall sluggish economy.
Despite the temptation, avoid retailers and other companies that make
non-discretionary consumer goods. Such companies will likely experience reduced
profit margins as they are forced to mark down their products to entice
consumers. (Also, find out what to do during a recession in our article
Recession-Proof Your Portfolio.)
Importance of Commodities
Commodities are the most fundamental of human essentials. Things like wheat,
corn, oil, zinc, copper and coal. While you might not physically buy some of
these commodities, you can't go through a normal day without them. Every time
you turn on a light switch or power up your stove, the electricity used is
provided by coal or natural gas. Grains are the basic building blocks for all
the foods we eat. Oil, besides being refined into gasoline, goes in things like
plastic, carpets, soaps and detergents.
Besides being essentials, commodities also have inflationary pricing power. If
the government prints massive amounts of money to combat the recession,
inflation will likely happen. It might not happen immediately afterwards, but
it will rear its ugly head. Commodities, for those reasons are a good place to
be.
Fertilizer companies are also great considerations. Fertilizer is the necessary
ingredient to boost crop yield - that is, producing more food from the same
amount of land. As the global population grows, so will the need to maximize
food production. When looking at commodity plays, focus on the larger
businesses with the quality assets such as the large integrated oil companies.
We will always need oil and the biggest companies have the deepest pocket book
to continue providing us with the black gold during various pricing
environments. Otherwise look for those companies that are the low cost
producers. (For more on investing in commodities, check out Commodities: The
Portfolio Hedge.)
International Investment Exposure
To illustrate why investors should also consider diversifying internationally
we can take a look at the 2007-2009 recession. Although this was a global
economic recession, it didn't affect every country equally. According to J.D.
Power Asia-Pacific, as of 2009, it was estimated that there were 820 cars for
every 1,000 people in the US. In China, the figure was 34 cars per 1,000.
Numbers like this illustrate the potential in countries like China, Brazil and
India.
Major international commodity companies are now almost certain to have exposure
to the growth in China. Such businesses enable investors to get the exposure
without having to invest directly in China. The growth engines for companies
like Johnson and Johnson is the fact that billions of people outside the U.S.
will need its products. (Learn more about China as an emerging market in
Investing In China.)
Conclusion
As long as investors are aware of the likely economic shifts that lie before
them in a post-recession environment, the opportunity to make excellent
investments is there. (For additional reading, check out Rules For
Post-Recession Investing and A Review Of Past Recessions.)
by Sham Gad