Recession In 2014? No, It's Here Now And What To Do

by: Emmet Kodesh

The weakening of the indices that began May 22 and resumed August 5 may look like a slide toward a recession. In my view, and that of others cited below, that's a bit behind the game. Bond yields rise as investors world wide dump or avoid "return-free risk": August 21 the 10-Year hit 2.87% and Fed infusion could not support equities that collapsed toward the closing bell. These are belated signs of the fact that we have been in a de facto recession since 3Q 2011 as retail sales have been signaling since then: despite a recent ostensible uptick, we are down 30% since then. A rise the last few months is belied by the 2Q earnings reports of our major retailers. Main Street has been sending out distress flares while the main news meme is upbeat.

In a June 12 article I suggested that worsening economic basics would result in "Recession in 2014." I have been pointing to U-6 jobless rate that has been near 15% for three years, declining real income and rising debt for citizens and leverage in the markets. Since taper talk late in May I have noted the damage it has been doing to the fragile recovery in real estate, debt service and consumer spending. I agree with Barry Bannister, Managing Director of Stifel Nicolaus that the worst damage to the economy results from government policies.

Last Thursday, as I was writing a piece about inflation and gold, retail expert Howard Davidowitz stated that "the economy is in collapse." He underscored I often have made that 75% of new jobs are part-time, no benefit positions. He noted the earnings miss for Wal-Mart (NYSE:WMT), the nation's biggest retailer (150 million customers), for Macy's and that Target (NYSE:TGT) would miss. "Business is bad in America," he stated, saying there was a 50% chance of a recession in 2014. "We've spent all that money [$7 trillion QE] and the economy is in the tank," he exclaimed.

He's wrong: rather than "a 50% chance that we will be in recession next year" we are in one now and have been for two years, since the Standard & Poor's credit downgrade in 3Q 2011 and major decline in retail sales growth. This fact is masked by faked measures of inflation which is in the 7-10% range as I showed August 15 (I omitted property taxes, up 34% in 4 years) and by GDP. Note: even at a very weak 1.5% 1H, GDP includes government spending on itself and double-counting without which growth likely would be below 0%. When one adds genuine inflation, our economy is near minus 10%. This is a recession. We must acknowledge it; consider what can be done to mitigate it and how one can invest to find a reasonable amount of gains in real dollars.

Given massive debt creation and high inflation, the USD is worth about half what it was in summer 2008. One tries to find a way through markets made treacherous by law, fiscal policies and currency manipulation which create massive crosswinds and instant downdrafts few individuals can master or ride.

The Bull is old: it is, as I have been arguing since February, a cyclical bull within a secular bear that began in 1Q 2000. To run with an old bull and not get trampled when it collapses, one must hitch a ride on mega-caps in major sectors. One must also have a hand in the PM (precious metals) sector and hope that the defenders of things as they are have lost many if not all of their means for suppressing PM prices. Depressed commodities offer some hope but if the current global recession (China is a possible exception) deepens, and von Mises' classic explication suggests that this is inevitable, there will be more inflation and then a deflationary depression. That also will hurt commodities but less than many equities. Bonds will be ravaged and acquire the volatility of speculative penny stocks as the mages try to unwind QE or let it reach its terminus till bond prices pop and deflate.

I again urge that you buy the wheat (NYSEARCA:WEAT) or DJ-UBS grains ETFs (JJG) which are at or near secular bottoms.

This is the first in an occasional series of articles suggesting what retail investors can do to help themselves best. I briefly review strong companies in key sectors. Do your due diligence and choose one or a few that seem best to and for you. Today I look mainly at true Consumer Discretionary (I explain here, here and here why this does not include major media-entertainment). If QE is continued and expanded, which I believe likely in the short term (4-6 months at least) the sector will recover. In the mid - long term, the macro situation, Sovereign policies and cultural change will challenge this sector and the structure of American society.

At present, Johnson & Johnson (NYSE:JNJ) looks strongest. Its $70 billion revenues arise from deeply entrenched products and are 7x its total debt, a superb ratio. Its cash flow alone is 1.6 x debts and its revenue growth is a vibrant 8.5% producing $4.50 EPS. JNJ gives solid income, paying 3.3%. While some might quibble with the 55% payout, the same as McDonald's (NYSE:MCD), like the latter JNJ maintains its dividend with a 5-year average of 3.3%.

Second and third choices are TJX (NYSE:TJX) and Home Depot (NYSE:HD). Like JNJ, both have very strong revenue and revenue growth / debt ratios. TJX revenues of $26 billion are 20 x debts on 6.8% revenue growth. It is in the sweet spot of what our culture is and has added online outlets and overseas affiliates that sustain its impressive low-cost growth. TJX cash flow is double its debt and it has respectable $2.62 EPS. Its dividend is only 1.1% but the payout ratio is a small 18%. One buys or owns TJX for growth not income. HD has similarly impressive metrics: $76 billion revenues nearly 6 x total debt with cash flow of $6.4 billion half of debt. Its $3.15 EPS sustains a 2.1% dividend, down from the 5-year average of 2.8% to keep the 40% payout ratio from rising. Its dividend is twice that of TJX with similarly healthy growth and revenue/debt basics.

At the mega-end of the sector, CVS (NYSE:CVS) and Procter & Gamble (NYSE:PG) are stout in hard times. PG's $84 billion revenues are 2.7 x total debt and for a behemoth operation, cash flow .45/debt is solid. Those who want to see strong revenue growth will not like its .6% pace but at this scale you are paying for a foundation. The $3.86 EPS is good and the dividend is steady: currently 3% with a 5-year average of 3.3%. Despite a high payout, 59%, the $14.4 billion cash flow tells you it will be there. Cutting the dividend to the 2 -2.5% range could boost growth but if you want that your choices are JNJ, HD or, in the large but less massive space, Macy's (NYSE:M) whose $28 billion revenues are 4x debt and has $3.42 EPS with 1.6% growth and a 2.2% yield on a modest 25% payout.

At the smaller end of the sector, Starbucks (NASDAQ:SBUX) stands out. The coffee is bitter but the metrics are great: $14 billion revenues are 26 x debts and growth is a stellar 11.7%. Like TJX, one doesn't choose SBUX for dividend, 1.2% on 38% payout but for its excellent growth and profitability. Dunkin' Brands (NASDAQ:DNKN) is tiny but continues its rapid growth (14%) fueled by debt that is 2.7 x revenues. Both coffee-based companies will thrive in the increasing bifurcation of society as SBUX retains profitability but loses market share to DNKN, a Boston-area company whose national expansion has been rapid and whose sweet, filling and colorful products appeal as an antidote to those damaged by economic realities and unconcerned with sophisticated atmosphere.

In closing I again commend to you the many merits of British Petroleum (NYSE:BP), United Tech (NYSE:UTX) and Boeing (NYSE:BA). All have excellent revenue / debt ratios and decent (BA, 3.4%) to excellent revenue growth (UTX 15.9%). BP is a revenue and dividend king, $400 billion and 5.2% respectively on a moderate 26% payout. All three companies are aligned with trends in geopolitics and governance. In the ME (media-entertainment) sector, CBS (NYSE:CBS), Disney (NYSE:DIS) and Time Warner (NYSE:TWX) stand out for similar reasons and have roles intrinsic to cultural formation and change and to governance and socio-economics.

Don't forget PMs which I will cover in a forthcoming article. For sustainable low cost growth supported by multiple productive sites and a plethora of pending development projects, First Majestic Silver (NYSE:AG) is sound. See my focus piece here.

Choose among these companies to shape your core holdings. If you wish, flesh them out with Vanguard's low-cost ETFs for Mixed Industrials (NYSEARCA:VIS) and Consumer Discretionary (NYSEARCA:VCR). They will help keep you above water during what is likely to be a long recession and a very big chill.

Disclosure: I am long BP, CBS, AG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have several of these companies in diversified ETFs and funds.