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Five Themes You Need to Know for 2008


What you need to know (and what it means)!


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Deflation

If 2007 was the year of inflation worries and stagflation nightmares, 2008 will be the year of deflation.

  • Throughout 2007 the message from the Federal Reserve Open Market Committee has been relentlessly the same:
    - "The Committee judges that some inflation risks remain." - Jan. 31, 2007
    - "[T]he Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected." March 21, 2007; May 9, 2007; June 28, 3007; August 7, 2007
    - "[T]he Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully." Sep. 18. 2007; Oct. 31. 2007; Dec. 11, 2007
  • Relentless.
  • In fact, one has to go all the way back to February 2, 2005 for the last FOMC statement that did not express concern about inflation.
  • And we have to go all the way back to December 9, 2004 to find the point at which the Fed declared victory over deflation, or, as they prefer to call it, "an unwelcome fall in inflation."
  • Meanwhile, isn't oil a hair away from $100 a barrel?
  • With the exception of the final six months of 2006, crude oil has risen almost without pause since January 2002.
  • And isn't gold at a record high?
  • Since May 2001 gold has risen from $260 to over $850.
  • These are signs of inflation (or stagflation), not deflation right?
  • A common misunderstanding is that falling prices causes deflation.
  • No. Deflation causes prices to fall, falling prices do not cause deflation.
  • And while the price of crude oil, gold and other commodities has certainly been a trend followers dream, the trend is only your friend until the end.
  • We have deflation right now, it's just that no one is talking about it.
  • A decrease in the supply of money or credit and a decrease in the demand for goods related to the inability to access credit is a perfect deflationary cocktail.
  • You will know it in financial markets characterized by a rising dollar, falling interest rates, and ultimately a declining stock market.
  • Looking ahead, we will be talking about deflation by the end of 2008, not inflation.

2. Consumer Recession

It hasn't happened since 1991, but after 16 years prepare for a "consumer recession" to make headlines.

  • Of course, this isn't exactly going out on a limb. We know that.
  • In fact, according to an NBC News/Wall Street Journal poll, more than two-thirds of Americans believe the US is either in recession now or will be in 2008.
  • Now we're part of the crowd.
  • The reason we bring this up is because the very act of labeling a "recession" is something that typically takes place as it is concluding.
  • Thus, the opportunity lies not in the media's confirmation of what we already feel and know, but in recognizing the rear view mirror that will produce those headlines.
  • Bottom line: Once the recession is officially confirmed, we can begin to look for what will appear on the other side.

3. The Coming Cleansing

Granted, a common theme for every new year is "getting in shape," and "kicking vices," etc. but I like the metaphor of this week's cover story in Time Out New York, "Get Clean!"

  • It covers everything from ridding one's body of antidepressants, religion, codependency, sugar, to being late and, of course, the obligatory drugs and alcohol advice.
  • Alas, there is no mention of financial "cleansing," but perhaps by June there will be.
  • After all, deflation is simply the cleansing process by which malinvestments are liquidated and destroyed.

4. The Rush to Disassociate

Many social trends frequently begin in the creative class and work their way out to "regular" society, so the story below seemed interesting, a comedian taking heat for making money.

Click to enlarge

If the 90s were about wealth, accumulation and consumption, 2008 will continue the mean reversion toward something altogether more austere, if not more sensible. Debt reduction and the rejection of (and guilt projection toward) materialism will continue what began in 2006 and 2007 as meditations on not just doing more with less, but doing less... period.

5. So, What to Do?

One thing I must make clear is that the economy is not the stock market. Inflation, stagflation, deflation, recession, depression, these are all interesting concepts and economic conditions, but the stock market is something else altogether; probably the reason economists seem to make such poor stock market forecasters.

So the question now is, what do we do in 2008? Where will we find the winners and losers?

First, the areas I believe we want to avoid remain the Financials and Consumer Discretionary sectors. Both sectors as we enter 2008 are deeply oversold in technical terms but, despite the potential for near-term rallies, the relative outperformance longer-term will come from other sectors.

What about Energy? As we noted in the first theme on Deflation, this sector has benefited for many years now from the near-unwavering upward movement in crude oil prices. It's now the officially "crowded" sectors. When we first began writing about the Energy sector in 2002 it carried a paltry 6% weighting in the S&P 500 . Over the past five years it has more than doubled and now comprises nearly a 13% weighting in the S&P 500.

This does not mean the secular trends benefiting Energy and Basic Materials is over. After all, in 1980 Energy and Basic Materials together made up nearly 40% of the S&P 500's weighting; today they make up a little less than half that. It just means we may need to take a break from their outperformance for a little while.

As 2007 marked the conclusion of the long-term outperformance cycle for small caps, 2008 I believe will mark a continued turn toward large cap and defensive sectors. Among the ones I like are Healthcare and Consumer Staples.

Below are 7 stocks to consider from those two sectors:

CVS Corp. (CVS)
Groupe Danone, ADR (GDNNY)
Hologic (HOLX)
Magellan Health Services, Inc. (MGLN)
Pediatrix Medical Group (PDX)
Procter & Gamble (PG)
Reynolds American (RAI)

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No positions in stocks mentioned.

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