The U.S. Economy’s Uncertainty Brings Opportunity for Investors in the Months to Come

By Jennifer Yousfi
Managing Editor

With a wheezing economy that's struggling with housing and credit problems - as well as a weak dollar - it's clear the United States won't be in the investment spotlight this year.

But don't despair. Because a trend that has long been talked about - economic decoupling - is finally starting to manifest itself as other world economies, particularly the so-called "BRIC" markets of Brazil, Russia, China and India, have continued to grow even as the U.S. economy has slowed. That means profit opportunities abound for U.S. investors, despite myriad messes on the home front that include a collapsed housing market, a mortgage crisis that turned into a five-alarm credit conflagration, and a plunging greenback that seems to have left its parachute on the airplane that it jumped from.

Some of the profit pathways to play:

  • Investors can eschew the U.S. market completely, and pursue profits abroad.
  • They can latch onto the U.S.-based members of the "Global Titans" club, companies with their headquarters in America that derive a hefty chunk of their profits from overseas markets.
  • Or investors can ferret out U.S. investments that are either immune to some of this country's current economic afflictions, or that are problem-plagued now, but a good bet for a turnaround later.

A Year to Forget?

Like a Dickens' novel, 2007 was a definite "Best of Times/Worst of Times" combination for the U.S. economy. Volatility and crisis were the watchwords for much of the year. After key stock indices reached record highs in the middle of the year, the explosive emergence of the subprime mortgage debacle and related credit crunch pushed share prices into a nosedive that steepened as the year progressed.

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With a 0.6% increase in gross domestic product (GDP) for the fourth quarter of 2007 and a first quarter that's supposed to be flat at best, it's clear that we're not out of the woods, yet.  Many fear that 2008 will find the United States in a recession.  Other investors believe we have already experienced the first elements of a recessionary contraction.

"If I had to be bold, I'd say we began a recession in December," Bill Gross, manager of the PIMCO Total Return Fund (PTTAX), told the Financial Times in a recent interview.

The Homeowner Blues

As 2007 progressed, many Americans experienced a growing despair as they watched their largest asset - the family home - experience a significant value decline. The United States is experiencing its worst housing recession in more than 15 years. And that domicile downturn is far from over. Consumers are being forced to watch as the housing slump siphons off the equity they've built up, even as it shaves the market value of their homes. Consumers with marginal credit who'd signed up for adjustable-rate loans have seen their mortgage rates "reset," and then had to watch as their monthly mortgage payment ballooned to the point that they could no longer afford those payments.

For many, unfortunately, refinancing hasn't been an option. The vanishing homeowners' equity made such deals unfavorable to lenders. And with the burgeoning credit crisis that quickly became global in nature, banks and mortgage firms have slashed the available amount of refinancing loans that homeowners needed to escape their soaring mortgage payments.

Soon, the banks that had made the questionable calls on subprime loans were in trouble, too. With the housing market cooling, the homeowners who couldn't refinance also discovered that they couldn't sell. Homeowner defaults - loans that are 30 days or more past due - soared and started a firestorm that has swept through the global financial-services sector, singing such stalwarts as Citigroup Inc. (C), Fannie Mae (FNM), UBS AG (UBS), and others.

"It will take most of the year to work out of the housing slowdown. Currently, the inventory of unsold homes is at an eight to nine-month level. We have to get this down to a more normal level of four to five months. In order to get to this level, housing starts will remain low," Dr. Robert Sweet, an economist at MTB Investment Advisors, the investment-advisory subsidiary of M&T Bank Corp. (MTB), said in an interview with Money Morning.

And we might be getting closer to the bottom. In fact, existing home sales rose in February, the first such increase in the past seven months. But it's probably too soon to get excited about a full housing recovery.

"It looks like this may be a temporary pause," Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Mass., told Bloomberg News after the existing homes sales report was released. "The price declines have helped, and people are still getting financing, though not on the good terms they could before."

"We're still a long way from a recovery in housing," Gault said.

The Fed to the Rescue?

U.S. Federal Reserve policymakers cut the benchmark interest rate by less-than-expected three-quarters of a percentage point at their last meeting, a move that was designed to energize a badly flagging economy without causing inflation to spike or exacerbating the greenback's decline.

When central bank policymakers reduced the key Federal Funds rate from 3% to 2.25% on March 18, it was the sixth time in seven months the closely watched benchmark had been reduced. Many analysts had been expecting a reduction of a percentage point - or even more - as such recent events as the near-collapse and subsequent Fed-led bailout of U.S. investment bank The Bear Stearns Cos. Inc. (BSC) stoked fears that the U.S. financial system was ready to seize up.

The policymaking Federal Open Market Committee (FOMC) has now cut the Fed Funds rate six times and slashed the Discount Rate for direct loans to banks eight times since August, when the subprime mortgage market collapsed and created a global credit crisis.

While the FOMC made it clear that inflation has grown as a concern, it still says that economic worries remain the biggest problem and emphasized that it was ready to act again if need be.

"Today's policy action, combined with those taken earlier, including measures to bolster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity," the FOMC said in its March 18th statement. "However, downside risks to growth remain. The committee will act in a timely manner as need to promote sustainable economic growth and price stability."

But while the Fed is definitely looking to do what it can to avoid a contraction in the U.S. economy, central bank Chairman Ben S. Bernanke faces a second - equally troubling - challenge. And no matter which route he chooses to take, the solution to one problem will exacerbate the second.

For that reason alone, the Fed has demonstrated some caution with regards to interest-rate reductions.

Seventies Flashback?

During the 1970s, the United States was afflicted with stagflation - crippling inflation coupled with stagnant economic growth and high unemployment. Until stagflation appeared, economists believed it to be an almost-impossible combination. Today, investors of a certain age remember the high fuel costs and long gas lines - along with the headlines about rising unemployment and a stalled U.S. economy that refused to be jump-started.

As U.S. economic troubles mount anew, some experts are using the "S-word" again. But stagflation is a worst-case scenario. The only thing worse than having either a recession or a period of inflation is to have them occur together. But Keith Fitz-Gerald, investment director of both Money Morning and The Money Map Report, believes that "the Fed will do whatever it takes to prevent a recession."

2008: The Year of the Greenback?

Much has been made in the press about the U.S. dollar's decline against the euro, yen, and other major currencies. But with the U.S. economy in such a decidedly weak state at the moment, a weak dollar gives the United States a competitive advantage abroad, which in turn is enormously helpful to employment at companies that that make products or offer services for export - and, by extension, is also helpful to the profits of U.S. companies with large international businesses.

At the top end, the weak greenback could even cushion the housing-market downturn, says Money Morning Contributor Editor Martin Hutchinson.  "Wealthy European and Asian investors will find bargains in fashionable markets such as California, Nevada and Florida where overbuilding had been most rampant," he said.

Also, while the dollar is weak, the U.S. trade deficit should continue to decline, making the dollar sounder and reducing the need to attract scarce foreign investors.

There are few factors more beneficial than a weak dollar [to a point] in restoring the U.S. economy to full strength. Ideally, the U.S. balance of payments deficit could be sharply reduced and the housing market stabilized before interest rates have to be raised to fight inflation. When rates are raised - and they will - the dollar will inevitably strengthen.

[Editor's note: While the falling dollar has roiled many investors, the ones who know why the dollar is falling are pocketing incredible gains. To learn their secrets - as well as profit plays on oil, gold, sovereign wealth funds, emerging markets, agriculture, uranium, biotech and much more - check out Money Morning's latest book, The Essential Investors Playbook.]

Good Opportunities Exist - Even in a Potential Bear Market

Money Morning's Fitz-Gerald cautions investors to remember that even though U.S. gross domestic product will advance at a modest pace of only 1% to 2% during 2008, the rest of the global economy will be doing quite well - with economic growth rates in some markets as high as 8% to 9%.  With foreign economies growing that briskly, there will be plenty of profitable investment opportunities available in the 12 months to come.

With growth sputtering and a recession still possible here at home, investors should turn their attention to such U.S.-based multinationals as McDonald's Corp. (MCD) and Yum! Brands Inc. (YUM). Both firms derive substantial portions of their sales from overseas markets, where growth is likely to continue over the next 12 months, regardless of what happens to the U.S. economy.

And while these firms offer significant foreign-market exposure, the fact that they're U.S. based means such corporations as McDonald's, Yum! Brands and such others as The Coca-Cola Co. (KO) and PepsiCo Inc. (PEP) offer the transparency of U.S. financial reporting requirements and the relative protection of the U.S. investment-regulatory system.

But if you prefer to invest more directly in foreign growth, then Hutchinson - the Money Morning contributing editor - says to try South Korea's largest wireless service provider, SK Telecom Co. Ltd. (SKM).  SK is well positioned to capitalize on the growing Asian markets. Likewise, the Hsinchu, Taiwan-based Taiwan Semiconductor Mfg. Co. Ltd. (TSM) [commonly referred to as TMSC], the world's largest dedicated semiconductor foundry, is another Asian tech company that is not currently overvalued and should do well in the New Year, Hutchinson says.

Traditional inflation-sensitive investments such as currencies and commodities are also good plays for 2008, investment gurus as Fitz-Gerald and "adventure-capitalist" Jim Rogers both say.

The PowerShares Agriculture Fund (DBA), operated by German giant Deutsche Bank AG (DB), is intended to reflect the performance of four commodities in the agriculture sector: Soybeans (31.13%), wheat (28.87%), corn (23.43%) and sugar (16.58%). These include some of the key agricultural commodity plays that Rogers advocates.

Another is Van Eck's recently launched Market Vectors Agribusiness Exchange-Traded Fund (MOO). Like the PowerShares Fund, this reflects the agriculture industry but in a different way. Instead, the ETF's holdings reflect returns seen from agriculture chemicals (34%), agriproduct operations (33.5%), agriculture equipment (24.3%), livestock operations (5.6%) and ethanol/biodiesel (2.3%).

For investors who have the constitution of a Contrarian investor - as well as some patience and a long time horizon - it may be well worth a look at some of the beaten-down financial-sector stocks that state-run sovereign wealth funds are buying into in a wholesale manner. Although many U.S. investors are preaching caution - if not total avoidance - when it comes to companies involved with the American financial-services sector, these government-run investment pools clearly view such stalwarts as Citigroup Inc. (C), UBS AG (UBS), Merrill Lynch & Co. Inc. (MER), and Morgan Stanley (MS), as bargain-basement investment opportunities.

Fitz-Gerald favors Citigroup.

"Citi is trading for a pittance," said Fitz-Gerald. "In fact, it's trading at just barely seven times trailing earnings and eight times [projected] 2008 earnings. Yet, if you add up the growth prospects and current valuations, the company reflects a value that could be as high as $60 or more a share. Value investors will recognize this as important because history shows that the lower P/E ratios are when you make an investment, the better your overall returns tend to be. Generally, large globally diversified companies are considered bargains at a P/E of 12, which makes Citi a screaming deal at 7 or 8."