Dividend stocks for income investors
See Jim's new portfolio to help navigate the treacherous interest-rate environment.
Jubak's Journal
Recent articles:
• 5 reader picks for tech's next big thing, 4/4/2006
• Fed kills a key inflation gauge, 3/31/2006
• OK, bash Buffett -- but buy his stock, 3/28/2006
More...
| | Jubak's Journal
5 stocks for the next spending wave
If the consumer is tapped, what will keep the economy humming? Business spending. And these companies stand to profit as corporations open their wallets.
By Jim Jubak
Here's the current consensus on the U.S. economy: Growth will taper off in the second half of 2006 as the Federal Reserve's interest rate increases gradually take the wind out of the red-hot housing market and consumer spending.
But the drop in growth will be very slight -- to 3.2% for all of 2006 from 3.5% for all of 2005 -- because an increase in capital spending by corporations will pick up the slack. Companies, flush with record profits, will spend more on new plants and equipment in the year ahead. According to a recent survey by Duke University's Fuqua School of Business, CEOs plan to increase capital spending by 6.5% in 2006. That's a big jump from September, when the same survey showed plans to increase spending by 4.7%.
And here's how investors in the stock market have acted on that consensus: They've driven up the share price of companies that sell the building materials and equipment that companies need to expand production. So, for example, shares of Florida Rock (FRK, news, msgs), a company that makes building aggregates and cement products essential for the building new plants, are up 18.5% so far in 2006, and shares of Wabtec (WAB, news, msgs), a maker of electronic systems for railcars, is up 25%.
Riding an aging cycle
But investing in stocks like these can be very tricky, especially after they've had a big run like this. These companies are all cyclicals, meaning that they belong to industries where revenue, and even more so profits, go through boom and bust cycles. In the railcar industry, the market that Wabtec sells into, the time between peaks has averaged five to seven years. At a peak, rail companies, looking at all their traffic and extrapolating future growth, order so many new cars that they create a glut. As the new cars are actually delivered, the supply outstrips demand, driving down the prices that rail companies get for their services and leading them to first gradually and then rapidly cancel future orders. That finally results in a trough, when no one orders cars. That ends when, thanks to the shortfall in the supply of cars, growing demand drives up the price of rail services again.
The time to buy cyclicals is near the trough, if you can figure out when that is. And the time to sell is when the cycle is nearing a peak. The last thing you want to do is to buy at the peak and then see the cycle go south on you and your investment.
More from MSN Money
That's why once the cycle starts to reach the length of earlier cycles investors start to worry. Cyclical stocks at this point face a constant demand from investors of "Show me we haven't reached the peak yet" before they're willing to buy. And that's where we are in the stock market these days: Many cyclical sectors are getting long in the tooth by historical standards, but investors continue to find reasons to believe that the peak is still a way away.
I think those arguments are largely correct. It is different this time in many cyclical sectors in that it's taking longer to reach the peak than it has in earlier cycles. The reasons for that range from the macro- to the microeconomic.
On the macro level (the level of the economy as a whole) first, companies have only reluctantly invested in new equipment this time around because they were so badly burnt by the supply glut in technology sectors in 2000. So it's taken longer to get CEOs to open their purse strings in this cycle, and they're still sitting on plenty of cash that already would have been re-invested in a more "normal" cycle. And, second, because so many basic industries, such as mining and railroads, have seen depressed profits for so long, there is a huge backlog of deferred capital investment to make up. Some on Wall Street say, for example, that the mining industry is just now making up for 20-30 years of under-investment.
For investors in basic industries and capital equipment, this extended macro cycle is good news. It means that winners still have longer to run.
But, I'd argue, the way to get the most out of this capital investment story -- and to get an extra margin of safety, too -- should look for individual cyclicals with their own micro-economic stories. That puts the economywide and company-specific trends both at your back.
|
