Exports Driving Economic Growth

Aligning your portfolio with the next industries to lead the economy and beat the market is basic to a sector rotation strategy. The current recession is causing some significant changes to the underlying economy that will affect investors. Surprisingly, companies that benefit from their export business are seeing their opportunities expand. There are some fundamental reasons for this change that will help them sustain their export growth. Exports will be the leading reasons for the growth the U.S. Gross Domestic Product (GDP) for several years to come. Look to align your portfolio with the sectors that benefit from exports.

The wealth of economic data that is available can overwhelm investors trying to identify the important facets of the current economy. Fortunately, the St. Louis Federal Reserve Bank through its Economic Data Fred® database provides a wealth of data in easy to read charts that are useful to explain important economic issues.

One of the biggest changes we are seeing in the U.S. economy is the massive deleveraging that is contributing to declining consumer spending. After living beyond their means by using the asset appreciation of their homes to fund a life style that was unsustainable, the average consumer in the U.S. has cut back. Those within 15 years of retirement are panicked they will not have enough saved to live comfortable after they turn 65, as they have seen their retirement accounts cut in half. Those in the 25 to 50 age brackets are realizing that they are responsible for their financial future. They have seen what happened to their parent’s investments, as well as their own and it scares them. As a result, almost everyone is saving more as shown in the chart below. When consumers save more, they spend less. Less spending, means fewer goods and services being bought, lowering the growth of the economy. Longer term, this is good, as the higher savings rates will create more capital for investment. It could even help to offset some of the massive borrowing by the federal government.

Not surprisingly, with lower spending many companies are experience a rapid drop in sales. When sales fall, their supply chains need to readjust to reflect the falling level of sales. This tends to cause inventories to rise. The sales to inventory ratio is an excellent indictor of the level of sales compared to goods available for sale.

The downtrend in inventory to sales since the early 1990’s is a reflection of the vast improvements made in aligning the supply chain with end sales. Instead of buying goods on the hope they will sell, now when a sale takes place an order is transmitted immediately back through the supply chain to initiate the production and distribution of another item. By lowering the amount of inventory in the supply chain, the cost of goods falls, benefiting everyone in the supply chain.

With the “new normal” as coined by Mohammed El Erian at Pimco, the lower level of spending per person will cause repercussions throughout the supply chain. The U.S. will need fewer stores, distribution centers, shipments, etc to supply the same number of people. Everyone in the supply chain will have to adjust a lower level of sales per person.

Not surprisingly, capacity utilization is showing the U.S. is using less than 70% of its available productive capacity, the lowest level since 1965 when this data series began. The U.S. has a lot of spare capacity available. Since consumers are not likely to start to return to their former spending levels, some of this capacity will not return. The permanent closing of factories, distribution centers, and retail stores is part of the underlying change in the economy to bring it back into alignment with a new normal level of consumption. This transition is and will continue to be painful. Longer term it will benefit everyone as the marginal facilities are removed from the economy. The ones remaining will contribute to higher level of productivity, making the goods and services produced in the U.S. more competitive worldwide.

That last comment leads me to where the U.S. is already becoming more competitive and the place where investors can find the best opportunities. As shown in the chart below of Real Net Exports of Goods and Services, the U.S. is experiencing a resurgence in exports, or at least exports are falling proportionally less than imports. The improvement in the country’s trade deficit is adding to the U.S. GDP growth helping to offset the fall in spending by consumers and business. Another indication of the strength of exports relative to imports is container imports for the port of Los Angeles, the nation’s busiest port, were down 18.4 percent in June 2009 compared to the same period in 2008 while exports showed a decrease of only 7.06 percent.

The change in this important component of the economy is likely to be sustainable. The massive spending by the U.S. consumer that took place over the last ten to twenty years is helping to spawn middle classes in countries such as China, India, Brazil, Korea, and Mexico that benefited from the U.S. demand for low cost imported goods. Now these people, who have money to spend, will buy goods and services from throughout the world, including the U.S. Helping to fuel this transition to an export economy is the fall in the value of the U.S. dollar relative to many currencies. A lower U.S. dollar makes U.S. goods and services less expensive for people and companies in emerging countries to buy. For those countries that peg their currency to the dollar, they will come under pressure to adjust their currencies to reflect their new higher level of purchasing capacity.

The cost advantage held by the emerging countries will diminish as their economies adjust to their newfound wealth. This will help to make the U.S. more competitive in the world markets, contributing to the country’s expansion of exports. The growing demand for U.S. goods and services will push the GDP of the country up, offsetting the negative affect of slower spending by consumers and businesses.

As a result, investors looking for ways to participate in the growth of U.S. exports, should look to sectors and companies that provides products and services currently and will be in demand by the emerging countries. The technology and industrial sectors will be the largest benefactors, followed by materials and some parts of the consumer discretionary. The rotation to more exports offers investors an opportunity to participate in a growth engine of the U.S. economy.

Sector rotation is a proven strategy that offers investors an excellent way to align their portfolios with the growth industries and companies in the economy.

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