Slow but better than expected growth--that's my forecast for the U.S.--and here are five picks for that economy

10/16/2012 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Could it be? More growth in the U.S. economy than expected?

It looks increasingly possible. If up until recently I was looking for a growth rate of “muddle through,” now I’m anticipating something like “muddle through plus” for the rest of 2012 and into 2013. (Assuming our friends in Washington don’t drive the country off a fiscal cliff.)

In numbers that means I now think the U.S. economy has a good chance to grow faster in the first quarter of 2013 than the 1.6% consensus among economists surveyed by Reuters. And to better the 2.1% growth forecast in the second quarter of next year. Not by much mind you. The 2.5% top in the Federal Reserve’s long-term growth forecast for the United States probably will continue to elude us. And a 2% or 2.25% growth rate is pitiful for a recovery from a recession—or even a bounce from a slowdown from a recovery from a recession.

There’s nothing here to get giddy about. 2% instead of 1.6% isn’t going to send job growth rocketing or see a stressed consumer suddenly feel flush. At 2% or 2.25% growth people are still going to be looking for bargains and watching dimes, if not pennies.

But even this kind of very modest improvement will change the investment landscape—and it should be reflected in your portfolio. I’m not talking about so much growth that I’d go out and load up on cyclicals or high multiple growth rockets. The recovery from the Global Financial Crisis hasn’t been that kind of recovery, by and large. And I don’t think this bump up in growth will change that.

But it does mean that consumer and retail companies that offer the right combination of savings and service and quality could be the stars of the stock market over the next six to eight months. Names that fit that description don’t necessarily come tripping off everyone’s tongue and they don’t have an automatic place in most portfolios. But at this juncture, with the economy looking like it might be better than “muddling,” I think it’s worth taking a look around at the potential candidates for a “slow growth” portfolio.

Before we get to individual stocks—and I’m going to give you five stocks today--however, let’s take a brief survey of why things might be ever so slightly better than seemed likely not so long ago.

One place to start is “surprise” indexes, such as the Bloomberg Economic Surprise Index and the Citigroup Economic Surprise Index. The Bloomberg index compares 38 economic indicators with analyst predictions. The index was up on October 12 to a minus 0.06 from the low for 2012, earned in July, of minus 0.42. The Citigroup index is even more positive—if you can say that about an index scored in negative numbers. In its October 12 report the index rose to a minus 49.4 from its low of a minus 65.3 on July 19.

Where are the surprises in the economy? For example, sales of previously owned homes, which climbed 7.8% in August to a two-year high. Or, for instance, the S&P/Case-Shiller index of home prices in 20 cities up 8% since March. And then, to take another case, auto sales at a 14.9 million annual rate in September. That’s the fastest pace since 2008.

This is good news but let’s keep it in context. We’re talking about two year highs that compare current levels to 2010. Or a 14.9 million annual rate that looks really, really good against an annual rate of auto sales that bottomed in the 9 million to 10 million range in 2009. That number, however, looks pitiful against the 17.6 million annual rate of January 2006. That’s BGFC—before the global financial crisis.

The single biggest reason to think that growth might be better than expected is the pent-up demand in the housing sector. When workers were afraid of losing their jobs, when families were cutting back on expenses, when neighbors were losing their homes, demand for housing as housing—that is not as an investment or a financial asset—was below historical trends. For example, the rate of household formation had been remarkably steady from 1958 to 2007 at about 1.4 million new households a year, according to JP Morgan Chase. But in the three years after the global financial crisis, the rate in the United States fell to 500,000 a year. We all know why and how—younger people without jobs or unable to find good-paying jobs or saddled with big debt moved in their parents or doubled up with a roommate. The rate of household formation has, however, doubled from that bottom and it is likely to climb even higher as the rate returns to something near its historical trend.

The population didn’t stop growing during the Great Recession either. The fastest growing demographics are the over-55s, who already by and large own homes, and the grandchildren of the Baby Boomers, who by and large don’t. JP Morgan Chase estimates that the United States will need 6 million new housing units by 2017 to meet the demands of a larger population.

In picking a slow growth portfolio housing is a good place to start. In the sector I’d suggest taking a look at these stocks for a start:

PulteGroup  (PHM), which focuses on the over-55 and first-time buyer segments. (In 2001 PulteGroup acquired Del Webb, the biggest builder of active adult communities.) At an average selling price of $259,000 in 2011, down from $322,000 in 2007, the company is exposed to the first-time buyer who is most likely to benefit from what looks like the gradual loosening of credit requirements for mortgages at U.S. banks.

Lumber Liquidators (LL), which is the largest retailer of hardwood flooring in the United States with more than 280 stores (up by 40 stores in 2011.) The company uses its size to buy big volumes directly from mills—the company acquired its largest middleman this year—and then sells flooring at “liquidator” prices. Comparative stores sales climbed by 7.5% in the first quarter of 2012 and by 12.4% in the second quarter.

In retailing I’d suggest:

Costco Wholesale (COST) just reported third quarter results that included a 5% increase in sale store sales on a 4.5% increase in store traffic, which comes despite a membership fee increase. Operating margins increased by 0.2 percentage points. Costco runs relatively few stores—just 439 in the United States—in comparison to competitors such as Wal-Mart (WMT) with its 3,925 domestic and 5850 international stores. But Costco scores about 2.3 times as much in sales per square foot as Wal-Mart.

Dollar General (DG) is the largest dollar store operator in the United States and, offering more consumables than its competitors, it is the most likely to be on the weekly shopping run of families looking to stretch their dollars. In the second quarter the company posted comparable store sales growth of 5.1%. That was impressive since it came after hard to match 5.9% sales growth in the year earlier quarter. Because the company continues to expand the share of consumables in its sales mix, gross margin fell to 32% in the second quarter, down 0.13 percentage points from the second quarter of 2011, but the company was able to cut costs to keep the EBIT margin (earnings before interest and taxes) at 9.8%, a historic high for a second quarter.

For my last slow growth pick, I suggest:

ZipCar (ZIP), which has slowed down quite a bit from the heady days in April 2011 when its initial public offering soared from $18 to $30. The stock closed at $7.34 on October 12. Even at the price ZipCar isn’t exactly cheap with a trailing 12-month price to earnings ratio of 245 and a projected forward P/E of 37. And I wouldn’t buy it here—I’d like to see the results of the company’s October 31 earnings report, for sure, at a minimum. But the company’s concept might be a great match to a slow growth economy. The company rents cars in major cities and at universities in the U.S. and overseas by the hour. The cars are garaged in neighborhoods and instead of going to a central car rental office, a member books over the Internet and then calls the garage where the car is stored (or goes to the parking spot on the street) and swipes in to the car’s onboard controller. The company’s computers have told the car to expect you. What’s neat about the service isn’t just that it’s perfect for running an errand and convenient for an overnight trip, but that you can sample cars that are a long way from the standard rent-a-car Camry or Chevy. Here in New York a member can drive a Mini Cooper, a Honda hybrid, an electric Ford Escape, an Audi A3 or Q5, a VW Golf, or a BMW 328i—as well as a more typical mix of Nissans and Mazdas. It’s a way to sample a cool car without laying out the big bucks to own or even rent one from a conventional rental car company. I think there’s an economic model here that’s exactly suited to a slower growing, more constrained economy—but one in which consumers haven’t lost their desire for fun. (And I wouldn’t mind finding a few more companies in this vein.) I’d like to see how the company handles growth and its capital spending plans for a few more quarters—or longer—but this is one pioneer that I think might be worth watching both for its own prospects and for the insight it provides on a new economic model made possible by the Internet and a less-than-exuberant economy.

Full disclosure: I don’t own shares of any of the companies 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 not own shares of any stock mentioned in this post as of the end of June (although I am a member of both Costco and ZipCar.) 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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