Given that we are into a recession that could last for at least a couple of years there are two questions we need answers to. What sector will lead us out of recession (historically it is banking) and how do we stock pick recession winners and losers.
For those who have not had business budget experience you have to run a Capital budget and a Revenue budget. Now keep in mind that Capital expenditure is non-tax deductable whereas Revenue is tax-deductable. Some companies have much higher capital budgets than others and those budgets are the first to get chopped in hard times. It is expenditure on new tools and equipment as opposed to running costs such as wages, advertising, envelopes, heating, rent.etc. A business will not invest in new office equipment or expanding a new manufacturing facility or upgrade to a more efficient process if the economic prevalent conditions are tough.
Companies with high capital budgets may still be able to do well because they have costs that can be cut without effecting the bottom line. A company with a high revenue budget and a low capital budget can usually only look to cutting staff and making efficiencies in all the remaining revenue items such as reducing advertising, turning the heating down or reducing the number of rented buildings. The effect is that the high capital budget companies do better during recessions. I have witnessed this in Engineering in three previous recessions.
Take for example the mining sector. BHP Billiton (BLT) may have had items in its capital budget to purchase a new storm pump from WEIR to replace an existing unreliable pump. The pump order can be cancelled until after the recession. They may have planned to install a standby conveyor from FENR to reduce production maintenance downtime but that order will also be cancelled. They may have planned to take a new power generation plant from AGK but that can also wait a few years. So you can see that BHP Billiton (BLT) has room to more or less maintain its output on reduced margins because commodities are cheaper but it can offset a lot of that against cutting its capital budget. FENR, AGK and WEIR who service BHP Billiton (BLT) are losers. They have no way to replace the cost of the lost order except by cutting staff.
So we have been used to oil support companies, mine support companies, power support companies all doing better than the companies they have been supporting. In recession the rolls reverse. Industrial support companies CHTR, FENR, SPX, WEIR, WG, AGK, WSM, CIU...etc will find it harder to get new orders for capital items. The actual power, mining and oil companies have more slack in controlling their finances.
Companies who usually need to invest to increase growth usually outperform their suppliers in a recession. Likewise companies generating healthy cashflow with low or zero borrowing should outperform. Cash rich food producers should also outperform.
It would also be wise to seek out companies that trade well on the back of the so-called 'cocooning'; this is when people stay at home watching TV instead of going out. Take the case of Domino's Pizza for instance which recorded bumper profits as families opted for a take-out as opposed to going out. Recently, Pace (which makes setup boxes for BSkyB) also announced that it had triples its profits.
Imo it's no good looking back at the price/earnings of the past few years. We have to try and assess the possibilities of performance in recession years.
So as a blogger has rightly pointed some of the good quality engineer support companies that have been loved in the past could be in a similar position that retailers were in last year.
I think the oil price/supply/demand is a most complex thingy. Its one thing for a company to go bust but it serves no one any good when it starts impacting on whole countries and their economies be they producer or consumer. The IMF are predicting the US to start recovery in the final quarter of 2009. They are traditionally optimistic but we will know as soon as employment starts rising and retail starts increasing. The International Energy Agency report says that 2008/2009 will be the first year of actual oil demand falling since 1983. If and that's a big if the US do come out of recession next year oil demand and price would be likely to remain low at least until 2010. After that it will depend on how much global credit is available for growth. Then there is new technology. Remember no internet, no mobile phones and man put on the moon with slide rules and log table calculations. I'm convinced liquid hydrogen cars will be in mass production within a handful of years.
The story is that gold falls into recession (don't know if depression is any different) and is the first commodity to rise as the recession is thought to have bottomed. The next commodity is wheat/corn followed by metals and then oil. I believe the thinking behind the pattern is that going into recession people are too afraid to spend their cash - even on gold. As the recession bottoms they realise that gold is about the only thing that has held its value so they start to buy. Traders know the pattern well from history and ramp the market. Joe public sees that interest rates are low and inflation is being talked about so joins in with physical buying of gold as their only flight to safety. Basic metals and grains follow on fundamentals of economic growth as does oil. The source is from various bits of personal research. Oxford Economic Forecasting, dailyfutures.com and historical gold charts. I'll see if I can dig out the documents I used but may take some time.
It's very hard to figure when we will get out of this because we don't really know when people will start spending again and how soon people can really make sense of the new normal e.g. living within our means; or some semblance of it.
Nor do we really know which companies, leveraged or not (and how do we really get to the bottom of it...the banks were hoodwinking everyone by holding all the debt off balance sheet), will recover quickly or are due to go bust. How do we know which companies are going to cut or quit their dividends? Anyone doing recently was punished by 30% falls.
I think the economy has to get a whole load worse before it gets better but the market will start to recover before the economy. In the meantime, this volatility looks set to continue...and my take is that it's very...very...very dangerous out there.
New Stockmarket Terms for Tough Times
CEO - Crappy Explanation Officer.
CFO - Crisis Fidget Officer (or was it fudgit!).
BULL MARKET - A random market movement causing an investor to mistake himself for a financial genius.
BEAR MARKET - A prolonged period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.
VALUE INVESTING - The art of buying low and selling lower.
BROKER - Just what the average investor feels in this market.
STANDARD & POOR - Your life in a nutshell.
ANALYST - Someone who just downgraded your stock.
STOCK SPLIT - When your ex-wife and her lawyer split your assets equally between themselves.
CASH FLOW - The movement your money makes as it disappears down the toilet.
VALUE INVESTING - The art of buying low and selling lower.
And finally for those into oil stocks....
POO - Exactly
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