Three Steps for Uncertainty

09/16/2005 12:00 am EST

Focus:

Jim Jubak

Founder and Editor, JubakPicks.com

"I think the Federal Reserve is facing a huge dilemma right now, and that uncertainty makes the stock market tough to read," says Jim Jubak. Here, he offers a three-pronged investment strategy to help investors cope with that uncertainty.

"Personally, I think the Federal Reserve will put off at least one of the two interest rate hikes that investors had been expecting in the remainder of 2005. Greenspan's Federal Reserve always likes to rely on data, data, and more data in making decisions. Right now, almost everything they know about the economy comes from before Katrina. That said, I'm certainly not 100% certain how the Fed will react, and that leads to my three-part stock strategy designed to avoid relatively predictable post-Katrina losses and to increase exposure to potentially profitable stocks and sectors.

"First, avoid those sectors that are going to take a post-Katrina hit from higher prices for energy and other commodities that are especially susceptible to a slowdown in consumer spending. Especially avoid sectors where the cost of likely business disruptions outweighs potential revenue gains from higher prices. I'm not talking rocket science here: In the next couple of quarters, companies in the airline, automobile and trucking industries will get slammed by higher fuel costs.

"Other sectors, such as retail and financial, don't require wholesale avoidance. But investors need to cut back on exposure to the shares of companies with higher-than-average vulnerability exposure to slower economic growth and slower consumer spending. In retail that means thinking twice (or more) about shares of companies with higher-than-average exposure to lower-income consumers.

"In finance, the same caveats apply to companies with substantial exposure to consumers with less-than-sterling credit. With railroads, I'd avoid companies where the potential damage to their system outweighs the company's ability to increase revenue by grabbing more traffic at higher prices. So I'd avoid CSX (CSX NYSE) because of its geographical exposure to system disruptions in the Southeast. On the other hand, I'd look to add shares of railroads with less regional exposure and better management such as Burlington Northern Santa Fe (BNI NYSE) or Canadian National Railway (CNI NYSE)

"Second, look for companies positioned to profit from the way that Katrina has shifted costs in the economy. The rapid rise in the price of oil and natural gas makes me look at shares of coal companies. Coal had a substantial cost advantage before Katrina. It looks even more attractive as an alternative fuel after Katrina. Peabody Energy (BTU NYSE) is the obvious choice but Penn Virginia Resources (PVR NYSE), with its greater exposure to Eastern coal (an advantage if shipping is an issue for the long term) runs a close second.

"Another place to look for companies like this is in the utility sector. Here, a utility such as FPL Group (FPL NYSE), the largest producer of electricity from wind power in the US, looks even more attractive in a post-Katrina economy. General Cable (BGC NYSE), a supplier to the utility industry, will see increased sales from infrastructure rebuilding along the Gulf Coast and from the continued push to increase the electricity grid's capacity to ship power long distances.

"In the oil service sector I'd look for shares of companies whose assets have escaped major damage from Katrina and that are positioned to gain major new work as the oil industry rebuilds. Cal Dive International (CDIS NASDAQ), for example, has a fleet of manned and robotic undersea construction vehicles that exactly fits the needs of oil and gas companies in the Gulf of Mexico.

"Third, and finally, I'd look to increase my exposure to sectors of the economy widely known for their lack of exposure to the price of energy. If worries about the economy start to get really serious, seeking refuge in stocks such as PepsiCo (PEP NYSE) and United Natural Foods (UNFI NASDAQ), which will start to look increasingly attractive to larger numbers of investors. But if worries about the economy don't intensify, I think the technology sector will be the place to be for investors seeking to avoid rising energy costs and looking for higher than average revenue growth. Broadcom (BRCM NASDAQ) is my one pick in that sector right now."

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