Barron's Interview: The Preconditions for Recession Are In Place

by: SA Eli Hoffmann

Excerpt from our One Page Barron's Summary (receive it weekly by email by signing up here):

INTERVIEW: Recession: The Stage Is Set by Sandra Ward

Highlighted companies: Wal-Mart Stores Inc. (NYSE:WMT), Newmont Mining Corp. (NYSE:NEM), Barrick Gold Corp. (NYSE:ABX), St. Paul Travelers Companies Inc. (STA), Delphi Financial Group Inc. (NYSE:DFG), Verizon Communications Inc. (NYSE:VZ), Windstream Corp. (NASDAQ:WIN), Supervalu Inc. (NYSE:SVU), JetBlue Airways Corp. (NASDAQ:JBLU), Dow Chemical Company (DOW)
Summary: Barron's interviews Richard Arvedlund, founder of Cypress Capital Management, which has $450m under management. First, his macro-economic views:

  • Recession: The preconditions are in place: (1) Housing drop of 10-20% (which usually signals a recession of unusual length). (2) Weak auto sales. (3) Inverted yield curve. "Where we had been looking for a slowdown, we now think there's a 40% to 50% probability of a recession. Next year could be a very difficult time in the U.S. economy."
  • Retail: Wal-Mart is his "favorite economist" due to its size, its market (low-middle income), and its monthly numbers. There has been a dramatic reduction in low-income spending. "I would suspect the retail-sales environment will be the next sector of the economy that we will start to hear less exciting news from."
  • Election: Lower capital-gains and dividend taxes have fuelled the current bull market. Although the current tax treatment, passed in 2003, is in place until 2010, even mentions of change are negative. The planned Democrat minimum-wage increase will raise unit labor costs and impact profit margins.
  • Inflation: Not a worry -- it will peak by year-end or early '07.
  • Oil/commodities: U.S. is the world's major consumer. If economic growth slows, so will consumption. "We think the price of oil could drop to a range of $45 to $50 by this time next year."
  • Interest rates: The Fed is finished raising short-term rates. He sees a 200-basis-point drop from early '07 to early '08. "I have never seen a slowdown or a recession where bond yields go up."
  • Dollar: "The dollar is about to resume a fairly extended decline." This makes foreign investments and precious metals attractive.
  • Stock market: It is highly correlated to GDP growth. He foresees flatlining or decline over the next 18 months.
His picks:
  • Gold: Newmont Mining Corp. (NEM) and Barrick Gold Corp. (ABX). He advises (clients) put 3-5% in precious metals.
  • Insurance sector: Dramatically underfollowed. He likes that their major assets are bonds, and picks St. Paul Travelers Companies Inc. (STA) and Delphi Financial Group Inc. (DFG).
  • Telecom: Another "interest-sensitive group." He likes Verizon Communications Inc. (VZ) and Windstream Corp. (WIN) who operate in areas not covered by wireless.
  • More picks: Supervalu Inc. (SVU) -- he knows and likes management. JetBlue Airways Corp. (JBLU) -- stand to profit from falling oil prices and rates. Dow Chemical Company (DOW) -- unloved company.
  • Quick comment: Excerpt from last year's Arvedlund interview