What if blue chip stocks in developed markets turn out to be your best defence against a deflationary depression? ExxonMobil (NYSE:XOM) is one of only three US stocks that retain the gold-plated AAA credit rating from S&P. The others?
Guess then. Go on. You know you want to. Here’s a hint: they’re in unrelated industries with different business models. What do they have in common: they consistently generate wads of cash.
OK, I’ll tell you. The other two are Johnson & Johnson (NYSE:JNJ) and Microsoft (NASDAQ:MSFT). A detailed balance sheet and income statement examination is beyond the scope of today’s letter. But I will tell you what I think you’d find if you looked closely: in addition to generating cash, all three companies do better than average at generating consistently high returns on invested capital.
Microsoft is famous for its cash haul. Exxon is known for huge capital investments to find oil reserves and produce them. And Johnson & Johnson for its brands. But all comes down to a version of the same thing: generating high returns on invested capital. It doesn’t really matter what business you’re in. You have to do it well, or you’re out of business.
These companies have other features that may make them more “fit for purpose” in the coming sovereign debt depression. They operate all over the world and have a diversified revenue stream. They can use their stock as a kind of currency to fund acquisitions. And, for now, they can generate revenues in nearly any business environment (although Exxon has the most to lose in a depression).
By contrast, sovereign debt markets could become the big “left field” risk this year. Governments – especially the welfare states – face lower growth, ageing populations and steady transfer payments from a shrinking tax base. They refuse to cut spending. And their borrowing mechanisms – selling bonds to the central banks – are under strain.
If you’re looking for a port in the coming storm, and you’re going to keep your money in the system (not in a mattress and not in bullion), the “fortress stocks” may be your best bet. In fact, according to a chart Charlie showed me earlier this week, the blue chip consumer non-cyclicals – businesses that generate even when the economy is not growing – have already received capital fleeing emerging markets in 2015.
Those non-cyclicals may already be richly valued. But investors aren’t buying them for next year’s earnings. I’d suggest they’re buying them to avoid this year’s deflation.
Category: Market updates