Stocks for a Slowing Economy

07/06/2010 11:24 am EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, is finding value in energy and staples giants.

The Weekly Leading Index (WLI) is published by the Economic Cycle Research Institute (ECRI). With a robust data set going back to 1949, the WLI has been a fairly predictable indicator of recession and recovery over the last 50 years.

By example, in mid-2007 the WLI projected recession in 2008, long before it was on anybody’s radar screen. In late 2008, when everyone was ready to bet the ranch on financial and economic Armageddon, the WLI projected a turnaround and recovery. In November of last year the WLI peaked and began to decline. Today it seems relatively certain that the WLI will cross into negative territory once again. Be that as it may, the WLI is not yet predicting recession, only that GDP growth has peaked and the economy is slowing.

Historically there has been a lag between a price decline in stocks and a decline in the WLI. Again by example, although the WLI projected recession in mid-2007, stocks did not begin to decline until November of that year. In similar fashion, the WLI turned down in November 2009 but stocks did not peak until late April of this year. The correction since the April 26th peak then appears to be an adjustment by the market to the likelihood of the slower GDP growth that the WLI is projecting.

Economist David Rosenberg of Gluskin Sheff has divided the WLI into four different phases. Phase 1 is Post Recession, where GDP growth goes from negative to zero. Phase 2 is labeled as Boom, where GDP growth goes from zero to the peak. Phase 3 is the Slowdown, where GDP growth moves from the peak back toward zero. Phase 4 is Recession, where GDP growth moves from zero down to the trough.

In Rosenberg’s opinion Phase 2 was from late 2008 into the fall of 2009. Since October, 2009 he opines, we entered into Phase 3 and could remain there for some time. In a recent post Rosenberg writes, “In Phase 3, historically, the S&P 500 has provided tiny positive returns (average price appreciation of 1.3%). Tech, industrials and energy are the top performing cyclicals, along with health care and staples in the more defensive area. This cyclical-defensive barbell works well.”

A quick glance at the S&P tech sector reveals three stocks in the current Undervalued category: Automatic Data Processing (NYSE: ADP); IBM (NYSE: IBM); and AT&T (NYSE: T). In the industrials sector the stock that jumps out immediately is United Technologies (NYSE: UTX), also currently at Undervalue. In the energy sector are Exxon-Mobil (NYSE: XOM), Chevron (NYSE: CVX) and Schlumberger (NYSE: SLB). Of these three the first two are at Undervalue and SLB just poked its head into a Rising Trend.

In the health care sector Johnson & Johnson (NYSE: JNJ) is the obvious standout and Abbott Labs (NYSE: ABT) also offers excellent historic value. In the consumer staples sector the world is your oyster: Clorox (NYSE: CLX), Coca Cola (NYSE: KO), Altria Group (NYSE: MO), PepsiCo (NYSE: PEP), Philip Morris International (NYSE: PM), Procter & Gamble (NYSE: PG), Molson Coors (NYSE: TAP) and Wal-Mart Stores (NYSE: WMT). Of the 17 stocks listed, nine are in [my] Timely Ten. With the exception of AT&T and Exxon Mobil, all have moved significantly off their March ’09 lows, retraced between 25% and 38% of those gains since the end of April, and appear to have stabilized and look as they may be getting under way again. While the Boom Phase may be over, there is still excellent value in great, high-quality companies; particularly in the energy sector.

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