Shaping a Portfolio–Pent-up Demand

“Pent-up” Demand

In weak economic times, individual consumers and corporations become afraid they’ll run out of cash and postpone purchases, creating unfulfilled or “pent up” demand for these items when times get better.

For what might be thought of as capital goods, that is, expensive stuff with a long lifetime, like a new house, a car, a refrigerator, or a new corporate headquarters, a data center, overhaul/replacement of the point-of-sale computer system–these purchases just don’t get made in bad times.

For smaller-value, more frequent purchases, like food or clothing, software upgrades, a new coat of paint–either these purchases aren’t made, or buyers “trade down” to a cheaper substitute.

Trading Down

Trading down is in the eye of the beholder, in many cases.   For the Macy’s customer, trading down may mean Target.  For the Target customer, it may mean Wal-Mart. For the Wal-Mart customer, it may mean the Salvation Army store. Some people may just wear what they own now and buy nothing.  So even though common sense says the high end of the chain loses but there may be someone at the low end who actually benefits from bad times, that beneficiary may be harder to find than you think.

Cutbacks in spending affect maintenance as well as new purchases, urban legends to the contrary.  While some may repaint their houses instead of moving, they are dwarfed by the number of people who will let the old paint job last another year (or two).   It’s the same with supposed purchases of “little luxuries” like a new tie or a lipstick.   Businesses will also stretch their preventative maintenance schedules for things like paint and sealants, and patch up old PCs as they break, or recycle them multiple times, rather than upgrade beforehand or buy a new PC or blackberry for a new employee.

Travel, entertainment and advertising are corporate areas that tend to be particularly hard hit.  Salesmen may make three trips a year to visit clients instead of four, fly coach instead of first class, stay in less luxurious hotels and have smaller entertainment allowances.  Conventions may be smaller, in cheaper venues–or not happen at all.  Marketers who believe advertising has created enormous brand value for them, may figure they can cut back for a short time without damaging the brand.

Each Downturn Is Different

Each downturn has its own peculiarities.  I’ve been a bit surprised that Starbucks and bottled water have been such early casualties of this recession, not that I’m a devotee of either, but because they’re relatively inexpensive.  I’d known that luxury goods companies have a much larger number of “aspirational buyers” than is usually appreciated, so this is not a great area to be in during a downturn, but the sales decline here has been pretty remarkable.  On the other hand, I hadn’t expected business purchases of new blackberrys to be up.

From an investor’s point of view, what I’ve written to this point is mostly information to be filed away and used when the next downturn occurs.  We’re trying to position ourselves to make money as the next upturn plays out.

Figuring the Upturn

For me, the main issue is this:  every downturn causes some behavior changes.  Some people will try Dunkin Donuts’ coffee because it’s cheaper and maybe never go back to Starbucks. Some will discover Target or Wal-Mart and switch allegiance from Macy’s. …or buy a Hyundai or Kia instead of a Toyota or Nissan and stay with Korean cars.  Others will switch back to their former favorites the instant they can afford to.  The big question is what will happen this time.

Remember, too, that we don’t need to have a comprehensive view of what the coming economic upturn will look like.  We’re looking for areas where we may be able to one or two stocks to supplement a mutual fund portfolio tilted toward economy-sensitive industries (namely, materials, consumer discretionary, technology and industrials).

Also, there are a lot of idfferent ways to make money.  Not everyone is going to have the same information or insights.  So there’s no “correct” answer.  There are just your peresonal guesses, the criteria you’re going to use to evaluate them and what needs to happen for you to confirm your beliefs/what would get you to change your mind.  (Please let me know if you have any good ideas.)

What I Think

For what it’s worth, this is what I think:

I think the overall economic recovery in the US won’t be as explosive as recoveries have been in the past.

I expect that white-collar workers below the age of, to pick a number out of the air, forty will have been relatively unaffected by the recession and will have no worries about going back to spending as usual.  One exception to this will be recent college graduates, who will be able to find jobs/find better jobs for the first time since they got their diplomas.  Their spending will also be strong, maybe stronger, for slightly different reasons.

In contrast, I think Baby Boomers will have been badly shaken by their loss of wealth so close to retirement age.  In addition, publicity about the underfunding of pension benefits–both by government and private corporations–and about what happens if your pension fund runs out of money won’t do anything to improve the BB mood.  My guess is that they will travel, replace their Buicks and do little else.  It may be harder than usual for the BB to find work in some industries, since the competition will be hordes of enthusiastic under-employed twenty-somethings.

Unemployment has been centered on construction and manufacturing workers.  I think the job loss in this area is much greater than officially reported, because of the presence of undocumented foreign workers in construction.  When construction resumes, who will be rehired first?  The mix between foreign and citizen will have an impact on the profits of companies that serve this market.

I don’t have any insight, either, into what the prospects for manufacturing industry are.  Among publicly-quoted companies, many have heavy exposure to housing and at least some have financing subsidiaries, where problems may still lurk.  I also think that what ultimately happens with the auto firms has the potential, for good or ill, to influence the multiple investors are willing to pay for US-based manufacturers.

What does all this boil down to?  I think we’ll have surprisingly strong growth in industries geared to the under-forty or under-thirty segment of the population.  I think this means video games, social networking, smartphones and action movies.  Travel-related (translation: hotels) may also do well, and get an added assist from the BB.

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