Make Money, Whatever Happens to the Economy
by Mark Gongloff
Tuesday, July 28, 2009
provided by WSJ.com


Some investors rely purely on mathematics when deciding which stocks to buy or investments to make. But many investors make those decisions relying to a considerable degree on imagination and faith, too.

These "story" investors envision a future path for the world, sometimes improbable, build a case for it, and then think, "How can I make money on that?"

Here are five such broad scenarios that many investors are considering today, at a moment when the economy and financial markets seem to be at a key transition point, from recession to uncertain recovery.

Some of these scenarios are in competition with each other, but all have their adherents, and all present opportunities.

1. The Jobless Recovery

In this widely held view, the recession might end soon, but businesses will be slow to hire again, resulting in a "jobless recovery." Abysmal for workers, this might not be catastrophic for stocks. Unemployment rose for more than a year after the 1990-91 recession, but stocks rose, too.

Companies that provide stuff and services that unemployed people need to survive are more likely to thrive than those offering more luxurious fare. This group includes consumer-staples providers like Procter & Gamble and Kraft Foods, discount retailers like Wal-Mart Stores, drug makers like Pfizer and utilities like Duke Energy.

More surprisingly, some analysts also believe technology and telecommunications firms can survive in a jobless recovery, too. Mobile devices are increasingly staples, and tech can help businesses boost productivity. This could benefit telecom firms like AT&T and diversified tech companies like IBM.

2. V-Shaped Recovery

In this scenario -- which isn't the consensus forecast -- the U.S. economy bounces back more quickly than most observers imagine, tracing a "V" shape, rather than the "L" or "W" many investors expect. Such a rising tide can lift all boats, with extra pop for riskier investments such as commodities and high-yield corporate debt.

But the universe of small-capitalization stocks -- companies with a market value of less than $1 billion -- could be an even richer mine for investors in a V-shaped recovery. Investors have been cautious about buying small-cap stocks so far. The small-cap Russell 2000 index has underperformed the Standard & Poor's 500-stock index since a market rally began on March 9, and investors have been raising their bearish "short" bets on the Russell index, says J.P. Morgan strategist Thomas Lee.

"The relatively higher short interest among small-caps likely reflects investor skepticism on the overall recovery," Mr. Lee told clients recently. "However, we believe a global economy recovery will soon be under way."

3. Hyperinflation

One nightmare keeping many investors awake at night is the prospect that heavy government borrowing and spending, along with super-easy Federal Reserve monetary policy, will eventually crush the value of the dollar, fueling hyperinflation.

As with a V-shaped recovery, this isn't the consensus view. But some smart investors are trying to position themselves for it, including Universa Investments, the hedge fund with ties to Nassim Taleb, author of the 2007 bestseller "The Black Swan," often credited with anticipating the financial crisis.

Expect soaring commodity prices, and invest in the companies that help produce them and pull them out of the ground. For example, shares of oil-services firms like Halliburton move more closely in line with oil prices than do oil majors like Exxon Mobil.

Other inflation-wary investors are more heavily invested internationally than in the U.S., believing foreign companies will outpace American rivals when the dollar collapses.

4. Deflationary Spiral

Many investors are still worried about the prospect of a deflationary spiral, in which consumers delay purchases as they wait for prices to keep falling.

In such a scenario, investors should look for companies that maintain pricing power regardless of the economic environment -- many of the same beneficiaries of a jobless recovery, including consumer staples, utilities and health-care firms.

Deflation means the value of the dollar is rising, which is bad for companies heavily in debt. Firms with clean balance sheets -- many tech companies -- would outperform those carrying a lot of debt. Deflation is very good to bondholders, offering fixed returns that keep rising in value.

5. Decoupling Is Real

In all of these scenarios, there is a chance that fast-growing emerging markets such as China can thrive regardless of what's going on in the U.S., Europe and Japan. This is the so-called "decoupling" theory, which lost some credibility when a sinking U.S. economy dragged the rest of the world with it.

Decoupling is still a possibility, however, in a world not in the throes of a financial crisis. It would mean faster economic growth in emerging economies, offering U.S. investors a way to make money even when conditions are still sluggish at home.

A worry for U.S. investors in these markets is that they are still loosely regulated and highly volatile, warns Chat Reynders, CEO of Reynders, McVeigh Capital Management in Boston. That's why he favors companies in developed countries that serve emerging markets -- such as Canadian National Railway, which delivers coal to China, and Sims, an Australian metal-recycling company.

Rising incomes in China, India and similar economies will be a boon to agricultural companies that improve farming efficiency, such as Deere and Monsanto.

Though it will be years before China and other emerging markets can carry the world on their shoulders, says Mr. Reynders, "growth of the middle class and the growth in infrastructure are immediate issues that have long-term viability."