It’s a scary and volatile world at the moment: floods, cyclones, earthquakes, tsunamis, US housing crashes, Aussie housing bubbles, the GFC, QEII, PIIGS, Japanese debt, revolution in the Middle East and Charlie Sheen. As the Chinese curse goes, we are living in interesting times.
So what’s a bear to do? I’ve never been the “head for the hills” type. Gold, silver and lead (preferably small calibre) may be great when the proverbial really hits the fan, but I am not expert enough to differentiate between it hitting the fan and the planet just having a bad month. Besides, I prefer my investments to generate returns. My business partner The Prince considers gold a “security asset”, which is a fancy term for insurance, not investment. Unless gold ingots suddenly become intelligent and start making Ipods or a better drink than Coca Cola, they’ll remain exactly that. Making money from them assumes some other sucker trader investor will pay more for them than you did.
So for a simple, returns-loving bear like me the only other options are deposits, bonds and equities. The first one is a given; cash is king when things look pear-shaped and no bear would be caught without it. In fact I’ve got a hefty chunk of my assets in the paper stuff. Bonds are great too, but pretty hard to get a hold of in Australia unless you are a wholesale investor or want to pay a huge spread when purchasing government bonds.
The last choice – equities – will cause the bear the most consternation. What companies do you invest in during dangerous times?
The obvious thing to look for is safety – i.e. companies that will continue to generate after-tax profits even during down times. Even better are those companies whose products may actually have higher demand during a recession. Straight away we can forget very small caps and most mining stocks. Discretionary spending stocks like Myer (MYR) are also out the window – one doesn’t need a Gucci handbag to line up at Centrelink. Add to this list anything that is leveraged to the business cycle (Autos, Real Estate, Software, Technology, Banks) and we suddenly have very few industries to pick from.
Let’s look at some of those left standing.
Unless you really hit the skids, you’ll still be using power during a downturn. Power providers should be a low-risk, low yield option for share investment. Alas, building power stations requires a lot of capital which is more often than not sourced via debt (or capital raisings).
Power generation is also at the whim of government regulators as well as the massive vagaries of a future carbon tax scheme, so even the power on-sellers can get shafted. In any event, listed Australian companies that produce or sell power (e.g. Origin, Alinta) are generally poor investments with low Returns on Equity (ROE) and high debt. Origin just proved the point by announcing a capital raising to help pay down debt. You can get better returns on high yielding term deposits at almost zero risk.
Healthcare should be a winner at all times – no one wants to stay sick and our demographics mean healthcare services and products will be a growth industry for several decades. However, I am yet to come across an Australian healthcare company that doesn’t have terrible ROE, massive debt or is burdened by government regulation (think nursing homes). Cochlear is the one excellent exception to this rule, but it does have some FX risk given more than half of its income is foreign. On the whole, health care will be unhealthy for the bears portfolio.
The Vice Squad – Alcohol, Tobacco, Guns, Gambling
The industry bad boys of gambling, defense, tobacco and alcohol are also popular at any stage of the business cycle. However, Australia has no massive defence industry like the US, so exposure to recession-proof armaments companies is almost impossible. Ditto for tobacco. We have a few gambling-oriented companies (Tatts and Tabcorp) but they have very high debt and are at the mercy of government licensing. So basically, vice doesn’t pay too well in Australia.
Gotta eat, right? No matter what happens to the market we all buy milk, bread and vegies. And more often than not it’ll come from one of the two behemoths Coles and Woolworths. Coles is part of the mining/insurance/food conglomerate Wesfarmers, which is exposed to a multitude of risks (and poor business management), so bears should stay away.
Woolworths (WOW) has a very high and consistent ROE, manageable debt levels and experienced management. Despite recent pressure from Coles, it is still the dominant player and is an excellent company to own even at its current price. WOW is definitely a stock for the bear stocking.
During a recession, what little discretionary spending that survives will be further down the value chain. Australia’s economy is built upon a profligate, debt-riddled consumer that will be out of pocket in a recession.
“Two dollar” shops may actually do better than during good times – perfection for the bear equities investor. In Australia, the stand out discount seller is The Reject Shop (TRS) with very high ROE, very low debt and a great business model. With a recent correction due to the Queensland floods, TRS is looking good even at today’s price. Even if it doesn’t drop even further, it’s a definite buy for the equity bear.
The Debt Industry
The last and best industry during a recession is that which profits from bad debt. Whilst there aren’t too many listed loan sharks, Cash Converters (CCV) comes close. It has good ROE, negligible debt and experience in charging usurious interest rates on pay day loans. They won’t break thumbs, but they should do well during tough times.
Another debt-based company for the bears is Fox Symes and Associates (FSA). They specialise in debt restructuring agreements and hold 51% of the Debt Agreement market. When debt problems go up, their debt services revenue increases. Nice.
FSA have forayed into low-doc (but very low LVR) loans recently, which will be a cause for concern during a downturn, but the majority of their revenue is still from debt services. FSA’s ROE is high (although volatile), debt is manageable and their market share is impressive. Given that they are trading at the same value as their equity per share, FSA is a steal right now.
So, if you are a bear that still can’t shake the equities habit then I’d suggest WOW, TRS, CCV or FSA. They provide either non-discretionary/ low-cost goods or counter-cyclical services. All things being equal they’ll do better during a recession, or at least not be killed as much as other equities. Remember, price volatility is not risk, it is opportunity to buy at lower prices and sell at higher prices. There will be plenty of opportunities going ahead.
If anyone has any other favourite bear stocks (I hate the term “defensive”), shout them out – I’d love to hear some differing opinions.
Disclaimer: Empire Investing and this blogger have positions in some of the companies mentioned above, and may consider future positions (both long and short). This post is general information only and is not a recommendation to invest.