Why We Still Have a Long Way to Go

As the consumer goes, so goes our economy. And if the newest consumer confidence figure is any indication, an economic turnaround won't happen any time soon.

The Conference Board just reported that U.S. consumer confidence fell to an all-time low of 38.0 in October, down from 61.4 in September, as their assessment of the economy "deteriorated sharply" and their expectations for the future "turned decidedly more pessimistic."

Among a number of disturbing trends, the report noted a steep decline in positive expectations …

… and rising pessimism:

Source: The Conference Board Consumer Confidence Survey.

This matters because, as we remember from macroeconomics 101, GDP = consumption + investment + government spending + (exports-imports). The rule of thumb is that U.S. consumer spending equals 70% of GDP, so it's easy to imagine that pessimism forcing a large-scale slowdown in consumption would drastically affect our economy. Perhaps even more concerning are the ripple effects of less consumption -- in response to reduced consumer demand, companies slow production, reduce hiring, and hesitate to make large investments.

A vicious cycle
The specter of slowing economic growth is especially bad news at a time when the world is dealing with a debt crisis fueled by excessive borrowing and creative financing.

Our gluttonous borrowing habits may have been what kept the U.S. economy growing at a decent clip over the past 10 years. If that's the case, we can expect a reversal in those borrowing habits to have a major impact on economic growth.

Earlier this month, Michael Mandel wrote a great piece about this topic for BusinessWeek:

According to the official numbers, economic growth in the U.S. has averaged 2.7% over the past 10 years. But by BusinessWeek's calculation, U.S. consumers have run up about $3 trillion in excess borrowing and spending over the same period -- consumption that was not justified by income growth. … Looking back, it has become clear that rampant borrowing and spending by U.S. households concealed fundamental weaknesses in the rest of the domestic economy. U.S. economic growth, outside of personal consumption, averaged only 1.3% per year in the 10 years ending in 2007, the slowest rate since the 1950s.

Scary stuff, especially when you consider that a big chunk of that $3 trillion in excess borrowing will need to be paid down in order for the larger U.S. economy to return to a healthy level of growth. That means two things: Consumers will spend less and even sell assets to accelerate the deleveraging process. We've already seen this in the housing and stock markets -- we may now begin to see it in retail and supermarkets.

Put simply, we still have a long way to go before we see a strong economic recovery. That doesn't mean you should stop investing, but it is cause enough to rethink how you're investing.

What to do
Unless you have at least a seven-year time horizon and can handle volatility, I would steer clear of companies that are highly dependent on surplus consumer spending like Abercrombie & Fitch (NYSE:ANF), MasterCard (NYSE:MA), and Best Buy (NYSE:BBY). All three may be fine longer-term investments, but they're currently facing strong headwinds as more customers put off new purchases. It's critical for investors in such companies to listen to how management plans on addressing this secular shift in the economy.

On the other hand, now is a good time to look for beaten-down, dividend-paying companies that aren't so reliant on consumer spending, particularly in the energy and health care sectors.

BP (NYSE:BP), for instance, currently posts a 7.9% dividend yield and trades for 5.5 times next year's earnings. Master limited partnerships like ONEOK Partners (NYSE:OKS) that operate oil and gas pipelines and post hearty yields is another group to consider if you want to limit exposure to the U.S. consumer.

Health-care companies like Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE) have their own set of risks, but are much less cyclical than the larger market. Consumers may put off buying that new HDTV, but they'll be much less inclined to stop taking their medication and receiving medical treatment.

Investing in dividend-paying and recession-resistant stocks such as these should give your portfolio some added protection if we do indeed face a prolonged downturn in consumer spending and the economy.

Foolish bottom line
The sad truth is that this market is downright ugly and shows little sign of near-term recovery while the U.S. consumer tightens its collective belt and the global economy slows. In this type of market, you would be wise to look for beaten-down, dividend-paying companies that create products and services that people need versus what they want. This way, you'll reduce your downside risk and generate income for the long road ahead.

If you're looking for a few dividend ideas for this market, our Motley Fool Income Investor service can help. In fact, a number of energy and health-care companies are on their best buys list right now. You can learn more about a free 30-day trial to the service by clicking here.

Todd Wenning knows you can't always get what you want, but if you try sometimes, you just might find you get what you need. He owns shares of Pfizer, but of no other company mentioned. Pfizer, ONEOK Partners, and Johnson & Johnson are Motley Fool Income Investor picks. Pfizer and Best Buy are Inside Value selections. Best Buy is also a Stock Advisor pick. The Fool owns shares of Pfizer and Best Buy. The Fool's disclosure policy had a soda, its favorite flavor, cherry red.