SIVY ON STOCKS from money.com
May 4, 2001

Staggering toward profits

The economic numbers are hard to sort out, and some analysts are talking
about stagflation. The best stocks for this environment include consumer
products companies like Procter & Gamble.

By Michael Sivy

The most recent economic data all contradict each other. First we hear that
real gross domestic product grew at a 2 percent annual rate in the first
quarter -- a stunner, because just about everyone was expecting growth to
be down from the 1 percent rate of the fourth quarter. So no need to worry
about recession, right? But then we get employment data that shows payroll
numbers tumbling and unemployment up from 4.3 percent to 4.5 percent. In
addition, inflation pressures -- particularly labor costs -- are moving
ominously higher. Economists are starting to talk about stagflation, the
awful combination of inflation and low growth. The last time they did that
we had an oil crisis and a horrific bear market.

Don't take any of this too seriously. Confusion and economic cross-currents
are normal at this point in the business cycle. What we're seeing now is
the regular churning that occurs as the economy completes a slowdown and
struggles to get back on a growth track. For investors, the key is to
isolate the trends that really matter.

The most important one is that the economy as a whole is still growing.
Despite lots of scattered bad news, we still haven't has a single quarter
of declining GDP. We might get one, but it's hard to imagine that we'll get
two really bad quarters back to back -- and that's what defines a
recession. At worst, it looks as though we'll get what they used to call a
"growth recession" back in the 1960s -- a drop more or less to zero, but
not a meaningful decline.

That's basically good news for corporate profits. Companies can maintain
earnings during a brief growth recession by cutting costs. And a modest
rise in unemployment is also positive for corporate America, because it
makes jobs easier to fill, and restrains labor costs.

An uptick in unemployment is also likely to encourage the Federal Reserve
to cut interest rates. The majority of Fedwatchers expect chairman Alan
Greenspan to reduce rates at least a quarter percentage point at the next
Fed meeting on May 15. The continuing trend toward lower rates will
encourage home refinancing, which will add another $100 or $200 a month to
some household budgets and help keep overall consumer spending healthy.

What stocks are most timely at this point in the cycle? As I've said
before, I think that the big money over the next five years will be made on
the largest tech stocks. Nearer term, I think we could see strong
performance among defensive consumer stocks -- the shares of companies that
sell everyday products. No one is going to stop buying toothpaste or
detergent because of a mild economic slowdown. And a whiff of inflation is
actually good for consumer stocks because it makes it easier to raise
product prices.

One obvious candidate is Procter & Gamble [PG], with brands that include
Tide, Ivory, Head & Shoulders and Charmin. The stock has dipped since I
last recommended it, but since April 24, P&G has risen 12 percent. And I
expect that rally to continue.

P&G has a number of big issues. The company is in the midst of a
restructuring, and it could take a while to work through all the kinks. In
addition, P&G is bidding to acquire Clairol from Bristol-Myers Squibb. But
over the next year, P&G should emerge from its restructuring as a more
focused collection of extremely attractive businesses. What matters most
now is that the stock is depressed and that sales won't be exposed to any
significant economic downturn.

This past week, P&G announced a surprisingly solid 9.4 percent gain in
operating profits for the first quarter. Much of that was from price
increases. Still, analysts thought the results were encouraging, and
Salomon Smith Barney upgraded the stock to "outperform." Full-year growth
this year and next may be only around 7 percent, but P&G's growth rate
could be back above 10 percent by sometime next year. Add in a 2.1 percent
yield, and you're talking about above-average total return potential. At a
current price of $64 a share, P&G is trading at less than 21 times this
year's estimated earnings. That's pretty cheap, and any successful results
from the restructuring would just be gravy.

###

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