By John Wasik
CHICAGO, June 4 (Reuters) - To maintain your mettle as an investor in the face of mixed economic signals, you have to be able to be able to do what F. Scott Fitzgerald said was the test of first-rate intelligence: be able to hold two opposing ideas in your mind and still function.
On one hand, it’s counter-intuitive to buy into a decline. It doesn’t feel right, although you will get better prices on quality stocks. The standard approach, which I suspect most investors choose, is to retreat to the sidelines.
If you can take the risk, keep investing in solid companies. If you need growth in your portfolio, don’t pull out; embrace the long-term prospects of owning companies that produce consistent profits and dividends. A good place to look for profits are U.S. consumer staples and discretionary stocks. These stocks are among the most profitable in the world, have paid robust dividends and continue to benefit from the snail-like U.S. recovery that may be “de-coupling” from Europe and not moving in lockstep.
How can this be possible in the face of U.S. consumer confidence falling to its lowest level in four months in May, fears of a global slowdown roiling stocks worldwide and pathetic employment growth?
My theory is based on this: Slowly recovering U.S. home prices signal that the dismal housing recession may have bottomed out. When Americans absorb that reality, they will start to buy homes, cars, appliances and other consumer goods. And with the easing of oil and gasoline prices, more money will be spent on these other items. We’ve seen some of this activity recently in May retail sales, which were stronger than expected.
Corporate profits have already reflected the rebound, although employers have been extremely reluctant to hire based on the short-term anxieties in Europe and slack overall demand. Dividends, based on profits, are also robust.
S&P Capital IQ noted in its May 30 sector outlooks report that this year “estimated S&P 500 dividend growth will be 18.4 percent.” Investors hungry for yield have embraced dividend payers, spurring a 10.8 percent and 4 percent year-to-date increase in consumer discretionary and staples, respectively (through May 25).
There’s also a backstop to this optimism. S&P Capital IQ, among other market observers, is a firm believer in the “Bernanke put,” or the notion that the Federal Reserve will continue to support the U.S. economy through “quantitative easing” of keeping short-term rates low if growth slows again.
One way of tracking consumer discretionary stocks - who make products you do not need but will buy with extra cash - is through exchange-traded funds like the Vanguard Consumer Discretionary ETF. The fund owns more than 300 companies like McDonald‘s, Amazon.com, Comcast, Home Depot and Starbucks. These are pure consumer liquidity plays.
When the job market stabilizes even more and housing prices start to show life again, a wealth effect exhorts Americans to spend again on non-essential items. A good alternative to the Vanguard fund is the Consumer Discretionary SPDR.
Consumer staples, in contrast, tend to be less-glamorous items that people tend to still buy even during economic downturns. There’s a little overlap with discretionary stocks, but it’s unlikely that consumers cut back on things like tissues, toothpaste, drugs or discount stores when times are tight. Household goods, packaged foods, soft drinks and tobacco products tend to dominate this sector. When the general market swoons, it’s also a good time to buy.
Not surprisingly, consumer staples are sold by some of the oldest and strongest companies in the U.S. such as Colgate-Palmolive, Procter & Gamble and Kraft Foods. You can find them packaged in ETFs like the Vanguard Consumer Staples ETF or the First Trust Consumer Staples AlphaDEX ETF.
There’s an even better argument for a broad-based approach, because if you chase individual sectors to find growth you face additional risk -- you can often guess wrong. The SPDR Dow Jones Total Market ETF will virtually cover every U.S. stock.
Of course, there’s always room in my theory to be wrong. Housing will take a long time to recover. The job market is severely lagging when it should be in a healthy rebound. And there are always surprises when you least expect them in an election year.