Finding Outperformers in a Pay-As-You-Go World

Margie and I were flipping through channels and happened to stop on financial guru Suze Orman making the case that we're now living in a pay-as-you-go society. Her point was that credit of all sorts -- from credit cards to student, mortgage, and car loans -- was going to be more difficult to come by and thus more expensive. In a world of constrained lending, we go from a credit card mentality to a debit card mind set. We pay out of money that we already have, not out of money that we can borrow.

At a broader level, this means that the deleveraging we've been seeing at banks is filtering down to the public. As Mish observes, this greatly affects consumer outlooks: it's no longer about keeping up with the Joneses. Rather, frugality becomes the operative priority. When employment, housing values, stock values, and bond values are contracting, the incentive is huge to hang on to what you've got. You certainly don't dig a hole for yourself by going into debt. Pay-as-you-go is the prudent alternative.

There have been many comparisons of the current market/economic period with the 1930s and the Great Depression. Most of those comparisons, understandably, focus on how bad market and economic conditions could get. A better comparison, however, would be the ways in which financial crises affect societal attitudes for an entire generation. From the Roaring 20s to the Depression 30s, we saw a dramatic shift in attitudes about saving, investment, and risk. My grandfather, who lost his fortune in the that crisis, never went back to investing in stocks and bonds. He became a frugal saver, who kept many different bank accounts lest there be problems at any one institution.

That is the way of psychological trauma: A single set of painful, powerful emotional events can reshape perception and action. As the deleveraging of the consumer unfolds, I believe we'll see a similar reshaping of views: Fiscal prudence will become a mantra for households -- and eventually will be expected of government. Not all of that will be for the worst. In the interim, however, that deleveraging -- and the accompanying shift in attitudes -- will create winners and losers on Wall St. Companies that produce necessities and that create unique value will prosper over those that connote luxury; firms that are well-capitalized and generate significant free cash flow will have the advantage over those that depend upon borrowing--their own, and that of consumers.

I was looking yesterday at companies in my basket of stocks that were making fresh 10-day closing highs. They included Merck (MRK), Pfizer (PFE), AT&T (T), Verizon (VZ), Altria (MO), and Johnson & Johnson (JNJ). All make products that, rightly or wrongly, are perceived as necessities -- or at least affordable (and indispensable) luxuries. At the end of this month, we'll spend a little extra to get our kids the cell phones they want. We may very well, however, scale back our plans to buy them cars or travel abroad. As the recession unfolds, the companies that make the things you'll buy in a pay-as-you-go world may be the best place to look for market outperformers.
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Comments

[MTroy:]

This hits the nail on the head, but leaves out another major benefit... a large and (presumably) secure dividend. Except for JNJ (which I love for many reasons) each of these stocks yields over 5% and some are above 7%. I would suggest PG and KFT (Kraft) for the same reasons. Kraft is the old MO without the tobacco, which keeps me from buying MO directly.

2008 Oct 21 10:07 AM

[tx7:]

Getting the buying public off credit is like reforming a drug addict. Takes lots of work and the success rate is low. Saving is a bad word to most young people.Soon people will be back to there old ways and the next bubble will start.

2008 Oct 21 10:33 AM

[MarvinMBA:]

The US is trying to get us back into the old habits of spend spend spend. We are suppose to do what the government is doing now...buy buy buy on credit and forget about everything else. I suppose this downdraft is something most spenders do not like....their home loan bank dispenser ran out of money. Well the housing bubble put the final death pang into the credit expansion and the govenrment is doing everything it can to get it going again. Will it work this time???? Try to keep your hard earned savings in short term secure instruments because some day you will get the return you deserve...3% plus the inflation rate......the longer it takes for this to happen the greater the inflation rate is going to be....MarvinMBA

2008 Oct 21 11:03 AM

[bigbuilder13:]

Seems to me that in a market that was flooded with buyers for stocks, the general rule was to buy on dips in the averages and sell the rallys.

If the marked is now flooded with sellers, we should short the rallys and buy on the dips.

Am I missing something?

2008 Oct 21 11:06 AM

[Smarty_Pants:]

bigbuilder:

1) 'Shorting' is a dirty word, regardless of how sensible it might seem.
2) 'Buy and Hold' is the government/Wall Street's official stock market religion.

Suggesting any other approach will land you squarely in the crackpot camp.

Welcome to the club. :-)

2008 Oct 21 11:20 AM

[PastTense:]

While I agree with the general philosophy here, I wonder about the specific stocks. For example the US can not permanently afford double digit increases in health care costs forever. At some point the country is going to reach a breaking point. The result may well be European style health care costs controls. MO may well be vulnerable to further lawsuits--and the country might even get serious sometime about doing something about cigarette smoking. ATT and Verizon have problems with declining landline numbers--people are going cellular only. When you look at consumer staples like PG and Kraft, consumers might go further and switch to generics--rather than the expensive branded products they sell.

2008 Oct 21 11:22 AM

[Smarty_Pants:]

The author and MTroy make good points. Solid, profitable, dividend paying companies are the ones to hold.

If you choose this approach it might also be a good idea to keep a good amount of cash on hand as well. Buy some of those shares on days when the market drops like a stone and sell some back on days when the market rallies strongly so that you keep accumulating more shares over time by recycling your money. (ie. establish a 'core holding', with plenty of cash left. buy extra shares on dips, sell back an equal dollar amount of shares after rallies and keep the 'bonus' shares)

The market will most likely be range bound for some time. Take advantage of the ups and downs to buy cheaply and sell dearly and add a few 'free' shares to the core holding. Those 'free' shares will add to the dividends you collect and increase the effective yield of the initial core purchase.

Just a thought.

2008 Oct 21 11:29 AM

[jackooo:]

Past Tense....

If you want to do something about smoking, QUIT SMOKING.
For a country that send a man to the moon and then brought him back this is a no brainer.
Instead organizations spring up to fight tobacco. They would be better off fighting cancer. BUT that would be a worth while cause.

2008 Oct 22 11:17 AM