Traders work on the floor of the New York Stock Exchange a day after Hurricane Irene swept through the area on Aug. 29, 2011.Spencer Platt
Does this slow-growth economic climate necessarily translate into stagnant investment returns? How should savvy investors be positioning their portfolios?
To help answer those questions, we sought the wisdom of Morningstar StockInvestor editor Paul Larson and Morningstar DividendInvestor editor Josh Peters. They weighed in with their views on the current state of the economy, and provided ideas regarding investments that may hold up well–and even benefit from–this kind of environment.
Larson believes that it's perfectly reasonable to assume that we're "in a muddle-through decade" and that the mounting federal deficit "is not a sustainable situation."
This scenario presents two possible headwinds for economic growth, in Larson's view: decreased government spending, hikes in tax rates, or both. And though he thinks the economy will experience some growth in the decade ahead, it'll be at a depressed rate of 1 per cent or 2 per cent per year.
In a similar vein, Peters notes the last recession really lifted the hood of the US economy to reveal all of the structural challenges underneath. He also says that "it would be a mistake to presume that the US economy will return to historical levels of gross domestic product growth anytime soon."
Despite their lukewarm outlooks for the economy, both Larson and Peters think that investors can find pockets of opportunity. Larson suggests an all-weather approach of investing in companies with economic moats, which will have the pricing power and business strength to hold up well against inflation and regardless of the direction in which the economy is headed.
Larson thinks ExxonMobil epitomizes that type of company. The firm has delivered higher returns on capital relative to other energy majors, spurred on by its relentless pursuit of efficiency, technology, development, and operational improvement.
Furthermore, Larson thinks that the secular trend of increasing tightness in oil supply will vastly outweigh any potential near-term weakness from economic conditions. Moreover, this Larson favorite is trading at single-digit multiples of earnings, further adding to its appeal.
Larson also thinks Google is a top pick for what lies ahead. As with the aforementioned firm, he believes that the Internet search giant is well-poised to benefit from secular trends, such as the shift toward online advertising that will easily compensate for any potential headwinds from an anemic economy.
Analyst Rick Summer notes that Google's reputation as the premier search engine on the Internet provides a long runway for the firm's continued growth. Larson also highlights the stock's current valuation as a key attraction, noting that the stock is currently trading at about 13 times forward earnings, despite demonstrating robust growth in the 25 per cent to 35 per cent range.
Worthy High-Yield Plays
Meanwhile, Peters makes the point that carefully chosen stocks with strong, sustainable dividends can help investors combat the challenges of the current economic environment. He favours companies with limited vulnerability to recession, strong balance sheets, pricing power to offset inflation, and current yields that are large enough so that economic growth need not be the primary driver of investor returns.
Peters argues that Abbott Laboratories tops his list of companies with recession-resistant qualities. The firm boasts a broad lineup of patent-protected drugs, a top-notch diagnostics business, a strong nutritional division, and a top-tier vascular group.
He notes that its 3.7 per cent yield is lower than other Big Pharma firms' payouts, but believes that Abbott's limited exposure to patent expirations gives it the ability to increase its dividend in the years ahead. Peters estimates a dividend growth rate of 8 per cent to 10 per cent during the next five years.
Peters also likes National Grid , an international utility that provides electricity and gas transmission and distribution in the United Kingdom and northeastern United States. The rates National Grid charges are indexed to inflation, helping give the firm–and its investors–a built-in hedge against higher prices.
Additionally, Peters points out that the trend in renewable energy sources like wind, water, and solar creates plentiful opportunities for profitable capital investment. Yield-hungry investors will also appreciate the firm's projected yield of 7.6 per cent.
Finally, Peters points to Procter and Gamble as another of his "best ideas" for tough economic times. The world's largest consumer-products manufacturer features a lineup of household brands such as Tide laundry detergent, Charmin toilet paper, and Pantene Shampoo.
Although Peters acknowledges that worried consumers could trade down to non-name-brand consumer products in a weak economy, he maintains that P&G should be able to sustain its margins and impressive cash-generating ability in developing markets.
Peters also likes the firm's dividend-growth potential, noting that "P&G doesn't need a whole lot of volume growth to drive its dividend higher. Inflation and share repurchases alone could round out a worthwhile total return."
Esther Pak is with Morningstar.com