10 picks for a low/no growth global economy--and they're certainly cheaper than they were a week ago

08/05/2011 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Find me some growth! Please! Anywhere in the world.

Europe isn’t growing—the weaker economies are all locked into austerity budget cuts. The U.S. isn’t growing—unless you call 1.3% annual growth in the second quarter growth—and the budget cuts in the debt ceiling deal sure aren’t going to accelerate this economy. India is slowing. Brazil is slowing. Even China may be slowing.

So is it any wonder that the stock market is in a deep, deep funk. (Maybe we should call a 512-point drop on the Dow Jones Industrial Average something more than a funk, huh?) Sure stocks are reasonably priced or even cheap by historical standards—but that assumes something like normal economic growth. Do you see it? Anywhere?

And let’s be very clear on this: Without some growth there’s zero chance that the deeply indebted developed economies are going to dig their way out of debt. Or that stock markets will regain their legs and reverse the 10% drop of the last nine days.

What’s an investor to do? Well, as my contribution I’m going to give you 10 stocks that I think can still give you some earnings and revenue growth even in this slow global economy.

But let’s start with a quick survey of the growth—or lack thereof—landscape.

Might as well begin with the United States since the data is fresh in my mind. Second quarter economic growth just a 1.3% annualized rate. First quarter growth just an annualized 0.4%. That put first half 2011 growth below 1%.

And hopes that the slow first half was just a soft patch due to disruptions in the global supply chain as a result of the Japanese earthquake and tsunami have started to fade. The Institute for Supply Management survey put the manufacturing sector, the sector that has led the economy during the first stages of the recovery, close to slipping into negative growth with a reading of 50.9. The 50 level separates growth from no growth. On August 2 on consumer spending showed a 0.2% drop in June. That is worrying since actual spending fell even though consumer incomes inched upward. That combination can signal a loss of confidence in the economy that leads consumers to spend less in preparation for tougher economic times.

Oh, and don’t forget that debt ceiling package itself. Granted the budget cuts are very back-end loaded—meaning that the pain is delayed for years and years—but the country is still looking at $21 billion in reduced government spending in the fiscal year that starts in October. Whatever good cutting the U.S. deficit will do in the long run, in the short-run reducing government spending sure won’t add to economic activity.

And then there’s the cost imposed on the U.S. economy by what the debt ceiling deal didn’t do. Because the package isn’t really the kind of credible long-term deficit reduction plan that the credit rating companies were looking for, the United States still faces a good chance of getting downgraded from AAA in the fall. That would bring higher interest rates—unless the rest of the world is so horrible that the United States looks like a safe haven. Projections are that the higher rates triggered by a downgrade could knock 0.4 percentage points off U.S. growth. That’s a big deal when your economy is growing at just 1.3%.

What country (or countries) will pull the global economic train if the U.S. can’t? Japan? Puleeze. The Organization for Economic Cooperation and Development categorized Japan’s economy as in another recession the last time it did its survey with the economy shrinking another 0.9% in 2011. Europe? Well, the last time the OECD did its projections it forecast 2% growth for the countries in the EuroZone. But that was before the second Greek rescue package proved a bust in building confidence and before European exporters, the region’s strongest economies, reported slowing growth due to more expensive currencies. (Europe’s weakest economies are shrinking or eking out 1% growth as budget austerity programs bite. If you want to consider a scary prospect, think about the need for budget cuts in France to reduce that country’s deficit.) Think about this ratio: If the OECD projected 2% growth for the EuroZone when it was projecting 2.6% growth for the United States, what would it project in updated figures if projected U.S. growth dropped to 1.5% for the year? (The answer is 1.2% growth.)

There’s always the developing world, right? Certainly growth in these economies is stronger than in the world’s developed economies, but growth rates have been dropping. India just cut its forecast for the fiscal year that ends in March 2012 to 8.2% from 9%. With the Reserve Bank of India still committed to raising interest rates to fight inflation, I think that projection is headed lower.

Same story in Brazil where inflation is forecast to end 2011 at 6.3%, at the top end of the government’s target of 4.5% plus or minus 2 percentage points and to retreat only slightly in 2012 to 5.3%. And this despite increases in the benchmark Selic interest rate to 12.5% now with economists projecting a rate of 12.75% by the end of 2011. (Rates are expected to decline only slightly in 2012 to 12.5% by the end of the year.) You can imagine what punishment a 12.5% interest rate is handing out even in Brazil where double-digit interest rates are the norm rather than the exception. Still economists project that the economy will slow to a 4.5% growth rate, according to a Bloomberg survey, from 7.5% growth in 2010.

Nothing wrong with 4.5% growth. Economies in the developed world would sell their souls for that kind of growth. But 4.5% growth is a problem for stocks if investors had been expecting 7.5%. That’s one of the reasons that Brazilian stocks are in a bear market.

And it’s the big worry about China. Growth in China peaked at an 11.9% annual rate in the first quarter of 2010—a rate that no one thought was sustainable or healthy. Growth in the first quarter of 2011 was at an annualized 9.7% and then dropped to 9.5% in the second quarter. The World Bank is projecting 9.3% growth for all of 2011.

But the truth is no one knows because no one is sure how hard China will step on the brakes to control inflation that climbed to 6.4% in June. That month food prices climbed at an annual rate of 14.4%. There’s a chance that July will come in at 6.4% too, signaling that inflation has peaked. But if not? If China does decide that it has to continue to raise interest rates and bank reserve requirements will Beijing stop with one or two more increases—and will that be enough to tame inflation? Or will the government have to risk pushing growth lower to get inflation back under control. This answer to this wouldn’t be nearly as important if demand from China didn’t set the margin price for so many things from copper to fertilizer to soybeans.

Okay, that’s the backdrop. Now how—concretely—do you approach stocks in a low-growth global economy?

  1. Go for the few pockets of high growth that look likely to hold up in this environment, that aren’t highly leveraged to global demand, and that aren’t horrendously over-priced in comparison to their growth rates. Chinese Internet stocks, volatile as they are, fill this niche. Go for market leaders such as Baidu (BIDU) and Tencent Holdings (700.HK in Hong Kong.) In the United States Apple (AAPL) fits the bill.

  2. Look for individual companies with products needed by long-time horizon industries and that are in short supply. Customers will be reluctant to cut orders too steeply if they know that once they’ve stepped out of line, they won’t be able to get the supplies that they need. Mining equipment is one examples and I’d look at stocks such as Joy Global (JOYG) and Titan International (TWI).

  3. Look for companies that make products that raise profits, sales, market share at other companies. There are a number of these in the auto sector where auto suppliers selling components that save gasoline but that provide the power that drivers want in their driving experience are hot commodities. Here I’d look at makers of turbochargers such as Borg Warner (BWA) and producers of stop and go transmissions such as Johnson Controls (JCI).

  4. In tough economies investors have long looked to companies that sell low-priced consumer goods and services. McDonald’s (MCD) does well in down turns, for example, because consumers still looking to eat out find the company’s offerings an attractive price point. In this global economy I’d find similar companies with the twist that they’re doing business in faster growing developing economies rather than in the developed world. So instead of McDonald’s I’d look at Arcos Dorados (ARCO), the largest McDonald’s franchisor in Latin America or at Yum! Brands (YUM), which has hitched its KFC and Pizza Hut brands to growth in China and the rest of Asia.

  5. And finally I’d add a few growth stocks that have been beaten down and then beaten down some more, but where the longer-term growth story is still intact. These will require patience and the key is to get them cheap enough so that you can hold onto them for a year or more. One example that comes to mind is Brazilian airline GOL (GOL). Shares of GOL traded at $14.14 on April 29 but closed at $6.55 on August 4. The cause? The general bear market in Brazilian stocks; the effect of higher prices of fuel; a debt downgrade after GOL took on debt to pay for an acquisition, and increased competition in the Brazilian market that has put pressure on prices. The company cut its forecast for EBIT (earnings before interest and taxes) margins for 2011 to 4% from 10% on July 27. But take a look at the price now: Credit Suisse cut its price target to $10.20 from $17.21 after the margin news. But the stock traded below even that lower target price at $6.55.


I own most of these ten stocks (I’m not counting McDonald’s as a recommendation but as an example)  in Jubak’s Picks http://jubakpicks.com/ and my other portfolios—Apple, Baidu, Tencent, GOL, Arcos Dorados, Joy Global, Borg Warner, Johnson Controls, and Titan International. But I recognize that they aren’t the only way to tackle the current low growth climate.

For example, low growth—even with all the bad debt and bad debt scares floating around—means that you can take interest rate risk in developed economies off your list of worries. I think that makes dividend stocks that pay above the skimpy yields offered by government bonds a very attractive part of this mix.

I’ll take a look at some picks in that sector in my Tuesday August 9 post and I’ll update my Dividend Income portfolio too http://jubakpicks.com/ .

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio.  The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple, Arcos Dorados, Baidu, GOL, Johnson Controls, Joy Global, Tencent, and Titan International at the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

 

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