It's a new year, but if you're like me, you're still not convinced that the U.S. economy is benefiting from anything more sustaining than a massive inventory restocking, thanks to government subsidies and cooler hands at the wheel. Yet according to a famous Wall Street iconoclast, pessimist, and realist -- all the same person, I should add -- we could be dead wrong.
Growth on the horizon
Proprietor of the eponymous newsletter Grant's Interest Rate Observer, James Grant has made a career out of pointing out the proverbial elephant in the room (or on the trading desk). His 1992 book Money of the Mind describes the financial errors of 1980s, but entire passages could be taken as keen analysis of the recent crisis. Why, then, has this Gloomy Gus mustered something like bubble-gum enthusiasm for the future of the U.S. economy?
Profiled in a recent New York Magazine article, Grant sees economic redemption arriving courtesy of mightily benevolent cyclical forces -- roused in part by the equally cyclical character of human behavior. On the latter point, Grant references British economist Arthur C. Pigou, who wrote: "The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant." In other words, we swing from one extreme to the other, and then finally settle into a more measured, and more assured, outlook.
As for the economy, Grants posits the upside surprise borne of the 1980s, a period when double-digit unemployment yielded to a vigorous recovery. He reminds us of "the capacity of market economies to reinvent the nature of work." Here, New York Magazine notes the technology-driven productivity surge and free-trade evolutions of prior eras.
And if not?
In fairness, Grant has not turned into an eternal optimist. For one, he worries about the future impact of low interest rates and an expanded money supply. Still, his economic faith seemingly clashes with much of the hard data.
Housing, for instance, remains a headwind. The number of homes that may come onto the market because of foreclosure (known as shadow inventory) rose to 1.7 million at the end of September 2009. That's up 55% from the year-ago period. Meanwhile, a group of economists who, like Grant, called the crisis, point to the comatose securitization market, which formerly supported much of our mortgage, credit card, and auto lending.
So what's the takeaway for investors? Has the 10-month market advance turned the corner, seamlessly morphing from potential bear-market bounce into a justified bull-market rally?
Frankly, who knows?
In light of convincing arguments on either side of the economic debate, there are a couple of things investors can do to prepare for, and benefit from, whatever the future may deliver.
First, consider playing both offense and defense in your stock selection. A company such as Costco (NYSE:COST) offers exposure to consumer discretionary spending, while also selling plenty of necessities. Ditto for Wal-Mart Stores (NYSE:WMT), which has been stepping up its electronics offerings. Discount retailer Family Dollar (NYSE:FDO) just posted a kicker of a quarter, but management readily admits that it would rather operate in a stronger economy, all of which means that shareholders should do well regardless of macro movements.
Athletic-apparel competitor Nike (NYSE:NKE) and mid-tier luxury specialist Coach (NYSE:COH) are gathering retail momentum, yet they have the balance sheets to withstand another downturn. In the health-care space, Kinetic Concepts' (NYSE:KCI) wound-treatment technology is a money-saver, which means that the company should be able to excel in a reform environment. Interested in an aggressive energy play? West-coast refiner Tesoro has recently posted profits, and the company's prospects could really light up in a stronger economy.
Beyond stock selection, consider keeping a higher-than-normal percentage of cash in your portfolio as we move through the year. It'll provide a downside cushion, and should high-beta cyclical stocks such as Caterpillar (NYSE:CAT) suffer a sell-off, you'll be primed to take advantage.
Ultimately, even a market seer like Grant acknowledges that he doesn't know what the future holds. But that doesn't mean that investors can't profit in -- or from -- uncertain times.
