My thin reeds say the first half of 2010 will be surprisingly strong in the U.S.

02/18/2010 4:29 pm EST


Jim Jubak

Founder and Editor,

Thin reeds. You wouldn’t want to count on a single one to support much weight but bind enough of them together and you can sail across the Atlantic—or find a profitable investing trend before it’s visible in the official numbers.

Sometimes the reeds all point in different directions and you can’t build an investing tactic out of them.

Sometimes, though, day by day they seem to fall into bundles that promise to be strong enough to support a buy or two or three.

I think that’s happening right now. In recent days I’ve seen a number of thin reeds that bundled together add up to a stronger U.S. economy—for the next quarter or two—than most investors are now expecting. And certainly these thin reeds are pointing to a trend that you won’t see in the official economic measures such as today’s (February 18) disappointingly high numbers of workers filing initial claims for unemployment. Many of the official numbers—such as the 31,000 rise in initial claims to 473,000 when economists had been projecting a drop to 438,000-- still say the economy stinks.

The thin reeds I’m collecting, however, say that through the middle of the year at least U.S. growth will be stronger than expected. (They’re still not telling me anything good about the second half of the year. To the degree there is a pattern it’s not pointing up.)

So what’s all this talk about “thin reeds”? Have I been up late watching YouTube video of the Ra II expedition again? Channeling my inner Thor Heyerdahl?

Not in the least. If I’m channeling anyone it’s Leo Dvorsky, for 16 years the outstanding manager of Fidelity’s Contrafund. Fidelity owned Worth magazine when I first started work there in the early 1990s and I had a chance to talk with Dvorsky, by then sort of retired, when he dropped by to see what nonsense we journalists were passing out.

Dvorsky loved to toss out what he called a thin reed--an odd piece of data, something he’d noticed around Boston, some part of a quarterly report—and then spin out a trend from that scant evidence until it either seemed like the most logical thing in the world or collapsed of its own weight.

Working at a great mutual fund company that believed in giving its fund managers research and then more research, Dvorsky had thought hard about how a manager adds value.

 Part of out-performing the average investor is working harder and digging out information that few other investors have. It was tough then and even tougher now to get information that no one else had found when so much great information is available either free on the Internet or from relatively inexpensive sources.

Part of it, though, is what you do with that information. Can you put it together in new ways that let you see patterns before others see them? Can you turn a piece of information this way and that until suddenly you find meaning in it before anyone else has?

Can you take a thin reed, a piece of information that most other investors know but that they’ve decided doesn’t mean much of anything, and find a trend before the bulk of investors do? (And let me remind you that you do want the bulk of investors to find the trend that you’ve found and sooner rather than later. It’s their discovery that will lead to a higher stock price and profit for you.)

So let me run my collection of thin reeds by you—in no particular order--and tell you what I’ve built with them.

  • Whole Foods Market (WFMI) beat Wall Street earnings projections when it reported quarterly results on February 16. More importantly the company announced better than expected growth in same store sales of 3.5%. Whole Foods is what market researchers call an “aspirational” retailer. Aspirational retailers take it in the neck when the economy slows since consumers struggling to make ends meet go to Wal-Mart (WMT) and forego the organic blueberries and the wild salmon. Same store sales growth at Whole Foods along with the good holiday growth at other aspirational retailers such as Coach (COH), where sale store holiday sales climbed 3%, suggest that the U.S. consumer is feeling better than the still horrendously high unemployment numbers would argue. It’s important to note, though, that both of these two aspirational companies moved price points lower during the recession and the early stages of the recovery.

  • Credit-card companies mailed 398.5 million solicitations in the fourth quarter of 2009. That was a 46% jump from the third quarter and the first quarterly increase since 2007. But the bulk of that volume went to just the most credit worthy. About 84% of the total credit-card mailings in the fourth quarter were sent to consumers with a FICO score of 720 and above, according to Synovate. Mailings to customers with a FICO score of 620 or lower made up just 6% of the total.

  • Nokia reported a 30% jump in sales for the fourth quarter—and then announced that it would cut prices by 10% for all its phones. That puts Nokia’s cheapest smartphones in a price war with the mid-range models from Sony-Ericsson and Samsung. The price war comes even though Nokia is predicting a 10% increase in unit sales for the wireless phone industry in 2010.

Here’s how I bundle these reeds.

First, the consumer is if not in full-throated spending frenzy at least no longer hunkered down in fear. I think that means it’s time to make the transition from recession favorites such as Wal-Mart to the stocks of companies that will do better if discretionary spending picks up. (I’d put Jubak’s Picks McDonald’s (MCD) in that category since consumers have been hunkering down by eating at home instead of fast-food restaurants.)  Stocks that fit this description include Nordstrom (JWN), Williams-Sonoma (WSM), and Imax (IMAX). I wrote about an official number that adds support to this conclusion in my post .

Second, the recovery isn’t going to produce massive profit growth because everybody whether they’re selling wireless phones or PCs or whatever is trying to pick up market share by cutting prices. I’ve explained this phenomenon in my post  and in another post I’ve explained why this means the stock market could run out of gas in the third and fourth quarters.

Third, the credit crunch brought on by lenders reacting to the excesses that caused the Great Recession then by cutting back on lending now is by no means over. The expansion of credit that is evidenced in the increased number of cards being mailed out to consumers at the top of the credit score heap will fuel the economy for a while. But what a full recovery needs is looser credit for companies and consumers that are good risks but that aren’t perfectly risk free. I worry that the second half of the year—and 2011—won’t bring a significant loosening of credit. Banks are still busy reducing the size of their balance sheets by cutting their loan portfolios. Most banks aren’t trying to gain market share in their lending market or to acquire pieces of troubled institutions that would increase their balance sheets. (US Bancorp (USB) is one of the few still on the hunt and it sticks out like a sore thumb. It’s on my Jim’s Watch List, by the way.) Mortgage foreclosures are expected to rise to 4.3 million in 2010 from just 3.4 million in 2009. I can’t imagine that will make banks just giddy with joy about lending.

To me this signals that the U.S. economy, in the short run (that is the next quarter or two) is going to be stronger than is now expected, that staying in the market or even putting some new money to work in the market over the next quarter or so is a reasonable move, and that the second half of the year is still not showing any pattern that makes it look more promising to investors.
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