Economic stall could trouble investors

Monday, July 10th 2000, 12:00 am
By: News On 6

Analysts say companies that provide necessities, selected tech stocks offer safety net against recession

If the Federal Reserve has its way – and it usually does – the U.S. economy will slow later this year, if not sooner.

This could portend trouble for stock investors if the much-anticipated "soft" economic landing becomes a recessionary thud, market analysts said. The Fed has raised the overnight bank lending rate six times in 12 months to prevent inflation, but modulating the economy is not an exact science, said Alan Skrainka, chief market strategist for Edward Jones & Co.

Savvy investors may want to take some pre-emptive steps – or at least tidy up their portfolios a bit – in case the economy stalls out and companies struggle to meet earnings expectations, he said.

Some of the best places for investors to "hide" if the economy hits the skids are in the stocks of companies that make products that people believe are necessities. Those sectors include pharmaceuticals, beverages, utilities and groceries. Some technology companies could also be included in the list, but the importance of continued earnings growth in the still richly priced technology sector can't be overstated, Mr. Skrainka said.

"Even though most technology stocks declined this spring, their prices still reflect not only strong earnings but impossible-to-achieve earnings," Mr. Skrainka said.

Diversification important

Investors should take care to buy only the most solid technology names and diversify across the entire sector – computer hardware, software, telecommunications and fiber optics, analysts said.

Investors who get careless or greedy will "have their heads handed to them" if the economy nears recession, said Chuck Zender, a market analyst for Leuthold, Weeden Research, a Minneapolis research firm.

For example, Computer Associates International, the third-largest software maker, was bludgeoned Wednesday after it surprised Wall Street with earnings warnings. For the week, shares fell $20.19 to close at $31, a 39 percent drop.

Actually, second-quarter earnings, most of which will be announced over the next two weeks, are expected to be strong for most companies in the Standard & Poor's 500 index, according to First Call/Thomson Financial in Boston, which tracks corporate earnings.

And First Call expects third-quarter earnings growth of 18.5 percent over the same period a year ago, only slightly behind the 19.2 percent expected growth rate of the second quarter.

However, analysts and economists are expecting slower profit growth in the second half of this year and early next as the Fed rate increases take hold and the cost of labor and raw materials – mainly oil – rise. If that happens, then the isolated problems at companies such as Computer Associates could spread, Mr. Zender said.

"If the economy slows enough to really erode retail sales, then there are going to be some nasty surprises somewhere down the line in the technology area," Mr. Zender said. "If you are worried about your job, you may decide not to buy that cell phone or that second computer."

Choosing the performers

But not everyone is quite that bearish. Bill Meehan, chief market analyst at Cantor Fitzgerald & Co., said that even if the economy slows, he expects some technology companies to hold up well.

For example, he said, companies involved in "building out the Internet backbone," such as Oracle Corp. and Cisco Systems Inc., will continue to meet earnings expectations because that is such an expanding area.

And even software giant Microsoft Corp. should do all right even if the economy slows because its stock price has already been taken down 30 percent, primarily because of its antitrust fight with the government.

"I think it will help, too, that many of the overseas economies are improving, and they will continue to buy U.S. technology to increase productivity," Mr. Meehan said.

Investors who don't have the stomach for buying technology stocks in a slowing economy have some other options. At the top of most analysts' lists is the pharmaceutical area.

"People don't stop taking their drugs during an economic downturn," said Hugh Johnson, chief market analyst at First Albany Corp.

"These are necessities, not discretionary things, so the sales and earnings of these companies continue to grow no matter what the economy does."

Not only that, the more-streamlined U.S. Food & Drug Administration is now approving some 100 new drugs every year, and that will continue whether the economy slows or not, said Mr. Skrainka of Edward Jones. These new drugs continue to pump up sales for companies like Eli Lilly & Co., Pfizer Inc. and American Home Products Inc., he said.

And Mr. Skrainka said pharmaceuticals are "more than just a pure defensive play."

"These are growth stocks just like technology," he said. "I call them dependable growth stocks that aren't so tied to the economy. You are buying stocks that won't fall 50 percent in a day like the techs."

Other areas that should do well if the economy heads south are food retailers, consumer products, soft drinks and the most defensive play of all – utilities. Companies in these sectors also provide products that people use no matter what the state of the economy.

"Just because the economy slows, you don't stop eating; you don't stop drinking Coke and you don't stop turning on the lights at night," Mr. Johnson said.

A stock such as Coca-Cola Bottling Co. also has the additional advantage of being "priced at a bargain," Mr. Skrainka said. Coke shares have fallen from a high of about $53 a share earlier this year to the current level of $44. Grocery retailer Albertson's Inc. also falls into the "value" category at its current price of $34.50 a share, about 40 percent below its 52-week high.

"These stocks will do well in a recession, and they'll also do well if the economists are wrong, and we continue with a robust economy," Mr. Skrainka said.

Other options

Some other areas to at least consider as the economy slows are aerospace and defense companies, such as Boeing Co. and General Dynamics, and brewers such as Coors Co. and Anheuser-Busch, said Mr. Zender of the Leuthold Group.

The aerospace and defense sector holds up well in a slowdown because the government budgets its defense needs years in advance regardless of the economy, he said.

As for the brewers, well, consumers are going to drink their beer come what may, and may even drink more of it in a recession, Mr. Zender said.

In eight of the last 10 months in which the S&P declined at least 3 percent, the brewers outperformed the overall stock market, according to a Leuthold research report.

"I was kind of surprised to see that this group actually outperformed the soft drink companies," Mr. Zender said.

There is, of course, no guarantee that the Fed rate increases will slow the economy, but evidence is mounting that it's having the desired effect. Manufacturing expanded in June at the slowest pace in 17 months, according to the National Association of Purchasing Management's factory index. And retail sales rose only 3.4 percent in June, the smallest increase in almost three years.

"Everybody's attention is now moving away from worrying about interest rates to worrying about corporate earnings," said Chuck Carlson, co-manager of the Strong Dow 30 Value mutual fund. "Earnings will determine what happens to stock prices in the second half of the year."