What Companies Do Well In A Recession (Investopedia.com)

Industries That Thrive On Recession
by Andrew Beattie
from investopedia.com




Recessions are hard on everyone - aren't they? Actually, just as wars have their war babies (companies that perform well during war and suffer during peace), recessions have their tough offspring as well. In this article we'll take a look at the industries that flourish in the adversity of a recession and why they do so well when everyone else is struggling to make ends meet.

Discount Retailers
It makes sense that, as budgets feel the strain of an economic downturn, people turn to the stores that offer the most for the least. Discount retailers like Wal-Mart (NYSE:WMT) do well at any time, but this is not entirely true. They often suffer in good times as people flush with money buy higher-quality goods at competing outlets. To remain competitive, they are forced to upgrade their product lines and change the focus of their business from thrift to quality. Their profits suffer from either lost sales or less margin on the goods they sell.

In hard times, however, these retailers excel by going back to core products and using vast economies of scale to give cheap goods to consumers. Designers and producers of lower-end products also see an upswing as more people jump from brand names to make their paychecks go further. People may not like discount retailers, but in a recession most people end up shopping there.

Sin Industries
In bad times, the bad do well. Although it seems a little counterintuitive, people patronize the sin industry more during a recession. In good times, these same people might have bought new shoes, a new stereo or other, bigger-ticket items. In bad times, however, the desire for comforts doesn't leave, it simply scales down. People will pass on the stereo, but a nightly glass of wine, a pack of cigarettes or a chocolate bar are small expenditures that help hold back the general malaise that comes with being tight on cash.

Be warned, though - not all sin businesses prosper in a recession. Gambling, with the exception of the truly troubled gamblers, becomes an extravagance and generally declines during recessions. In fact, casinos do their best trade when the economy is roaring and everyone feels lucky. The most prosperous businesses in this industry are the purveyors of small pleasures that can be bought at a gas station or convenience store.

Selected Services
Expect a downturn in the service industry as a whole, as companies and families are willing to do more themselves to save money. A certain class of service providers will see an upswing during hard times though. Companies that specialize in upgrading and maintaining existing equipment and products see their business increase as more clients focus on working with what they have now rather than buying a newer model.

In the real estate industry, they say renovators hire as builders fire, and this holds true for many other industries as well.

The Statics
In a recession, simply carrying on with business as usual can be an achievement. Pharmaceuticals, healthcare companies, tax service companies, gravediggers, waste disposal companies and many others are in a category that, while not jumping ahead during a recession, can plod along while other companies suffer. This is simply because people get sick, get taxed and die (not always in that order) no matter what the economy is like. Sometimes the most boring businesses offer the most consistent and, in context, exciting returns.

The Benefits Of Recession
The biggest benefit of hard times is that companies get hurt for inefficiencies that they laughed off in better times. A recession means general fat trimming for companies, from which they should emerge stronger, and that's good news for investors.

One of the best signs is a company in a hard-hit industry that is expanding anyway. For example, McDonald's (NYSE:MCD) continued to grow in the 1970s downturn even though restaurants generally suffered as people cooked rather than going out to eat. Similarly, Toyota (NYSE:TM) was opening new American plants in the 1990s downturn when the Big Three were closing theirs due to falling sales for new cars.

A recession can be a blessing for investors, as it is much easier to spot a strong company without the white noise of a strong economy.

Waiting It Out
Although it is good to know which companies excel in a recession, investing according to economic cycles can be difficult. If you do invest in these industries during a recession, you have pay careful attention to your investment so you can readjust your portfolio before the economy rebounds, stemming the advances the recession-proof industries have made.

Some of the companies performing well in a recession will also perform well in a recovery, and more will change their business to take advantage of it, but many will be passed by their toughened-up brethren that race ahead in bull markets - financials, technology firms and other faster-moving industries. With the proper timing, however, these industries can provide a buffer within your portfolio while you wait for your high fliers to take off again.

Updating the Model Portfolio (from thestreet.com)

Kass: Updating the Model Portfolio
Doug Kass
07/27/09 - 12:01 PM EDT

This blog post originally appeared on RealMoney Silver on July 27 at 8:38 a.m. EDT.
In late April, I initiated the Kass Model Portfolio, intended to represent the general construction of a long-only model portfolio with a six- to 12-month investment horizon. My hypothetical portfolio depicts an overall equity weighting and positioning relative to S&P 500 industry benchmarks and weightings.

As I did in calling for a generational bottom in early March, I am again adopting a variant and unpopular view, but this time it is a more negative call. It is important to emphasize that in my March call, I expected a resurgence of economic and investment optimism during the summer to be followed by a multiyear period of weak investment returns. Specifically, I expected a mini production boom and an asset allocation away from bonds and into stocks to be embraced and heralded by investors, who would only be disappointed again in the fall as it becomes clear that a self-sustaining economic recovery is unlikely to develop.

Today's opening missive has another major change in our model portfolio, with a further increase in the cash component of the portfolio from 29% to 43%. I am further reducing both equity and credit exposure after a huge run in both asset classes.

As I see it, the bull market argument is that we are exiting the recession just like the many that preceded the current one. Consequently, corporate profits will exceed consensus forecasts in tandem with:


the resumption of revenue growth (seen in three months of improvement in the leading economic indicator, signs of stabilization in housing, etc.);

the record fiscal stimulation;

an export-led Asian recovery; and

the operating leverage associated with productivity gains achieved through draconian cost cuts and influenced by tame wage inflation.
Besides productivity being underestimated the bulls, further argue Say's Law of Production -- that it is business that drives consumer incomes and spending. Finally, the bullish cabal argues that the high-tax health and energy bills introduced by the President have been recently set back as the blue dog democrats and the liberal leadership are already battling.

The bear market argument (that I now endorse) is that we are seeing nothing more than a second derivative recovery and that owing to a temporary replenishment of inventories, the economy is only getting less worse (or getting better from a depressed level). From my perch, the ingredients for a durable and self-sustaining recovery are missing. An economic double-dip grows more likely in a climate of corporate cost cuts, which elevates jobless rates and leads to continued pressure on personal consumption expenditures. The bears reject Say's Law of Production and view consumer incomes and spending as driving business.

Importantly, the economic downturn of 2007-2009 has already been different this time in scope and duration. For example, unlike the other post-depressions/recessions of the last century, we have already witnessed two consecutive quarterly drops in nominal GDP. As well, the 20-month-old recession has resulted in a near 4% drop in real GDP vs. drops of between 2.5% and 3.0% in the mid 1970s and early 1980s recessions. The U.S. economy came out quickly from those prior downturns, with recoveries to new peaks in economic activity taking only three or four quarters.

My view, however, is that it is different this time: The typical self-sustaining economic recovery of the past will not be repeated in the immediate future for 10 important reasons that will come to the fore:


Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.

Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.

The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.

The credit aftershock will continue to haunt the economy.

The effect of the Fed's monetarist experiment and its impact on investing and spending still remain uncertain.

While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in the prior upturn.

Commercial real estate has only begun to enter a cyclical downturn.

While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.

Municipalities have historically provided economic stability -- no more.

Federal, state and local taxes will be rising as the deficit must eventually be funded, and high-tax health and energy bills also loom.
As I wrote last week, the most disturbing feature of the current business environment is the manner in which corporations are beating estimates. While it enhances the present profit configuration, it has the potential for a long and negative tail to the future. Cost-cutting, like another man's bread, will line the corporation with profits but, in the fullness of time, will not fill the belly of the consumer who is the victim of the realignment of expenses. Costs cuts have a finite life, and, as such, produce an inherently lower quality of earnings and a less positive lever to P/E multiples than does the classical cyclical improvement in top-line or sales growth.

Given the unusual nature and the severity of the downturn, it is hard for me to see anything typical about the domestic economy's rebound compared to previous recovery periods. I do not see the disproportionate role of housing and credit in the prior decade being replaced by anything similar as a growth lever in 2009-2011. Already job losses are unprecedented and cost-cutting's impact on unemployment will exacerbate pressures, acting as a greater drag in the years ahead. Meanwhile, other (nontraditional) headwinds -- such as the likely growth-inhibiting public tax policy, less available credit and an intrusive public sector's interference on the private sector (with attendant regulatory costs and burden) -- will weigh heavily on the economy. So will bloated budgets and poor planning, which have left municipalities in disarray, raise unfamiliar cyclical challenges.

My contacts with corporations are universally more downbeat than the optimism expressed by investors recently. Many in my hedge fund cabal say that this input from the industry is not unexpected, as company managements universally failed to see the coming downturn. This is a fair response, but I suppose they could be right for a change!

For now, the animal spirits are in force. Shorts are covering, and the longs are joining the ever more vocal and growing bullish chorus in the face of the enemy of the rational buyer -- namely, optimism.

In summary, my model portfolio's high cash position reflects a less optimistic view of the sustainability of corporate profit and economic growth as well as a renewal of excessive optimism in sentiment and a move toward more elevated valuation levels (which are not supported by the profit picture I foresee).


S&P Weighting Recommended Weighting Rationale for Weighting
Technology 18% 8% Business spending will remain subdued, and the sector is now overowned
Financials 13% 7% The risk of a double-dip augurs poorly for credit metrics
Energy 13% 5% Commodities, like energy products, are vulnerable to a slowdown
Health Care 13% 5% Government intervention threatens pricing
Consumer Staples 12% 5% Exposed to generic trade-down as consumer weakens
Industrials 10% 5% Shallow and uneven economic recovery remains a headwind
Consumer Discretionary 9% 4% Accumulated job losses and wage deflation weigh on consumer
Materials 4% 2% Shallow and uneven economic recovery remains a headwind
Utilities 4% 2% Exposed to a further spike in interest rates
Telecom 4% 4% Secular prospects remain strong
Total equities 100% 47%
Credit 0% 10% Opportunistic
Total exposure 100% 57%
Cash 0% 43%




Finally, I have included a shopping list of individual stock candidates (by sector) that could be considered in the aforementioned Kass Model Portfolio.


Technology: Previous selections Apple (AAPL Quote), Cisco (CSCO Quote), Research In Motion (RIMM Quote) and Oracle (ORCL Quote) are now fully priced and have been dropped from my buy list. Qualcomm (QCOM Quote) had a disappointing quarter and is also out. Remaining are Microsoft (MSFT Quote) and Dell (DELL Quote).

Financials: I'm dropping SunTrust (STI Quote), Regions Financial (RF Quote), Legg Mason (LM Quote), State Street (STT Quote), Berkshire Hathaway (BRK.A Quote) and Weingarten (WRI Quote) (convertibles). I added JPMorgan Chase (JPM Quote). Remaining are Bank of America (BAC Quote), Prudential (PRU Quote), MetLife (MET Quote), Hartford (HIG Quote), PNC (PNC Quote), Cohen & Steers (CNS Quote), SL Green (SLG Quote) (convertibles), Chubb (CB Quote), Loews (L Quote), National Financial Partners (NFP Quote) (convertibles) and SLM (SLM Quote).

Energy: I'm dropping extended integrated oils and several oil service companies and keepng Transocean (RIG Quote) and select master limited partnerships.

Health Care: I'm going with select depressed HMOs, a true contrarian play!

Consumer Staples: Remaining are Procter & Gamble (PG Quote), General Mills (GIS Quote) and Unilever (UN Quote).

Industrials: I'm keeping 3M (MMM Quote), PPG (PPG Quote) and Union Pacific (UNP Quote).

Consumer Discretionary: I have dropped Wal-Mart (WMT Quote), Nike (NKE Quote) and Starbucks (SBUX Quote). Remaining are Home Depot (HD Quote), Lowe's (LOW Quote), Disney (DIS Quote) and eBay (EBAY Quote).

Materials: I'm dropping BHP Billiton (BHP Quote), and only Freeport-McMoRan Copper & Gold (FCX Quote) remains.

Utilities: Duke Energy (DUK Quote), Dominion Resources (DRU Quote) and PG&E (PCG Quote) remain.

Telecom: The model portfolio continues to hold Verizon (VZ Quote) and AT&T (T Quote).

Credit: I added SLM debt to the other select bank loans/debt and high-yield debt.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

At the time of publication, Kass and/or his funds were long MSFT, DELL, BAC, JPM, PNC, MET, PRU, HIG, CNS, CB, WRI (convertibles), SLG (convertibles), NFP (convertibles), SLM (straight debt), RIG, HD, LOW , DIS, EBAY and FCX, and short JPM calls, PNC calls, MET calls, PRU calls and HIG calls, although holdings can change at any time.

How Understanding Sectors Can Help to Minimize Risk - WSJ article by Chris Kenney

SHAREHOLDER SCOREBOARD
How to Weather Turbulence
What investors can glean from the Scoreboard; one key: understand relative risk among sectors.

By CHRIS KENNEYFebruary 25, 2008; Page R2
Investors are worried. The Dow Jones Industrial Average ended last year 6.4% below its October record close and has fallen further since then. The housing market is in turmoil, banks are posting big losses and economic growth may be about to grind to a halt.
What can the Shareholder Scoreboard offer investors as they weather market volatility and recession concerns and need to reassess their investment strategy?
The Shareholder Scoreboard was developed in 1996 to provide investors with a long-term perspective on the creation of value in the stock market. For various time periods, it reflects the trends, bubbles, corporate winners and laggards that have affected investor returns. But given the rising uncertainty in the economy today, it is likely that investors are much more concerned with the immediate future.
THE JOURNAL REPORT

Best Performers (1, 3, 5, 10-Year)
Worst Performers (1, 3, 5, 10-Year)
• See the complete Shareholder Scoreboard report.
FINDING THE COMPANIES THAT SHINE

PODCAST: Chris Kenney of L.E.K. talks with the Journal's Georgette Jasen about some of the main themes in this year's rankings, using the Scoreboard as a starting point for looking at companies and sectors, and other topics.

Although stock-market history clearly has limits in its ability to inform us about the future, there are several investment insights to be gleaned from this year's Scoreboard that may help investors calm their nerves and balance their portfolios as they look at 2008 and beyond.
The first thing is to put the stock-market volatility experienced in 2007 (and so far this year) in some perspective. Although investors with limited experience or short memories might have been struck by the market's turbulence, we have experienced far worse volatility in recent years. Second, for those who want to manage their portfolio risk more actively, it is important to understand relative risk across industry groups to avoid the next sector downdraft. Finally, individual-company risk can vary quite widely from one sector to another, so investors who like to pick individual stocks should examine the range of returns within a given industry.
A look at each of these issues can help investors manage market risk when it begins to feel most unmanageable.
Be Ready for Turbulence
Investors certainly had a bumpy ride last year. Average daily price swings for the companies in the Dow Jones U.S. Total Market Index were more than 50% greater in 2007 than in 2006. Turmoil within the housing sector bleeding into the financial sector led to both real and perceived volatility.
Because we are all most influenced by recent history, the roller coaster that investors rode in 2007 might lead some to believe that recent market volatility is at historically high levels. Investors might be inclined to keep their money on the sidelines and wait for calmer times.
But the truth is that relative to the past 10 years, 2007 market turbulence was well below average. Volatility is typically defined using a statistical measure called standard deviation, which looks at how much or how little data diverge from the average. As the first chart indicates, even though last year was turbulent, six of the past 10 years demonstrated even higher volatility.
What can investors do in turbulent times? Clearly, the tried-and-true strategy of diversifying across asset classes, geographic regions and sectors should be the first line of defense. For example, had you invested equally across all the Scoreboard industry sectors, the return would have been an average 13.8% annually over five years. Alternatively, the average annual return on just five sectors would range from 1.1% to 59.6%, depending on which sectors were chosen.
Broad diversification across stock sectors therefore is one of the most useful tools in managing risk. Ask yourself if there is any reason to have more than 10% of your stock portfolio in any one sector. Then be vigilant in rebalancing your portfolio as the value of your investments changes over time.
Watch Out for Maverick Sectors
Yet even reasonably diversified investors can be burned by industry sector risk. For example, just a 5% exposure to the home-building sector in 2007 would have reduced a portfolio's total value by 2.5%.
So it is also useful to understand the extent to which industry returns vary from the overall market. Investors who commit too much of their portfolio to "maverick" sectors -- those whose returns deviate enormously from the market average -- can inadvertently assume more risk than they intend.
To illustrate this, we have identified 10 industry sectors that, over the past five years, diverged the most from overall market returns on a month-by-month basis.
The measure used is called R-squared. Simply put, it shows the relationship of movements in each sector to movements in the overall market. If the movements are 100% correlated, this means that all the stock movements in a sector can be explained by movements in the market. Alternatively, if R-squared is 0%, then overall stock-market returns explain none of the returns in the sector and sector-specific factors are driving stocks. We consider sectors mavericks if less than a third of their returns are explained by returns on the overall market. Here are the top 10 maverick sectors for the past five years:
You can see that only about 5% of the returns in the home-construction sector were explained by overall stock-market movements. Similarly, the overall market explained less than 1% of the returns in travel and tourism.
There is a logical explanation for these sectors to be so detached from overall market returns. Pharmaceutical-company fortunes, for example, are not tied to the general economy nearly as much as to the prospects for specific drugs. Similarly, cyclical and capital-intensive sectors like autos, forestry and paper, and semiconductors can deviate substantially from overall market returns.
It is useful for investors to know what percentage of a portfolio is invested in maverick sectors. Though the past is not always prologue and industry dynamics can change, ask yourself how likely your target sectors are to move based on broad economic or sector-specific factors.
Another reason to identify maverick sectors is that, in moderation, they can be quite useful in diversifying portfolio risk. For the very reason that they tend not to move with the market as a whole, they can help offset movements in the market.
The implication is not to avoid these sectors but to keep your exposure manageable. Balance your stock investments with modest exposure to one or more maverick sectors, but don't let them grow to more than 10% of your total portfolio. And include a mix of more market-oriented sectors.
Among the sectors that most closely tracked market returns:
Some of these are sectors closely tied to industrial and commercial activity (industrial services, commercial vehicles and trucks). Sectors that are closely tied to movements in interest rates (utilities, life insurance) and relatively stable goods and services are also represented (medical supplies, waste and disposal services).
Stock Pickers Beware
Just as industry sectors can vary widely in their levels of volatility and risk, so too can companies within sectors. In some sectors, company stocks move quite closely with sector returns. In others, company returns can vary widely from sector returns. This is because company returns in these sectors are affected by unique factors rather than factors that affect all companies in this sector. In these cases, individual stocks carry greater risk.
Consider the semiconductor industry in 2007. Company returns deviated enormously from the average return of 28.6%. A top-performing company in this sector was MEMC Electronic Materials Inc., which generated a 126% return. The worst-performing company was Advanced Micro Devices Inc., whose return was minus 63%. Most investors diversify their investments to eliminate most of these company-specific effects. For those who may decide to own one or two stocks within a given sector, however, it is useful to know which sectors have companies whose returns deviate the most from the sector average.
Using standard deviation as a measure of how tightly data are clustered around the average (low standard deviation) or, conversely, how widely dispersed they are (high standard deviation), we can see that returns for companies in the following 10 sectors deviate the most from the sector average. Presumably that's where stock pickers are taking a proportionately greater risk when they invest.
Again, there is some logic behind "high deviation" sectors. Chemicals and semiconductors are capital-intensive and highly cyclical industries. The exposure of individual companies to these economic cycles can vary dramatically. Similarly, industries such as biotechnology, with companies that depend on the discovery and successful development of new products, should be expected to demonstrate a broad range of returns.
The sectors with the lowest standard deviation of company returns include:
These tend to be consumer-oriented products or slower-growth sectors where companies may have less opportunity to generate differentiated returns.
The key lesson from the Scoreboard data is that the market's volatility in 2007 wasn't extraordinary. If this volatility proves unbearable, you can always reduce your exposure to stocks. But there are two questions you might ask first:
• Am I too exposed to "maverick" sectors, those that don't track the overall market? • Am I too exposed to a small number of stocks in "high deviation" sectors, where returns on individual stocks deviate widely from the sector average?
Reflecting on the answers can help manage investment stress in turbulent times.