Headwinds and Tailwinds

Living in New Mexico and enduring countless wind filled springs, we consider ourselves experts on wind. Brown outs, finding sand in your ears and discovering your patio furniture in your neighbors’ yard is all part of the fun in the spring. Usually, the wind blows from the west but sometimes it seems to be swirling all around our state from every direction.The recent global financial crisis was a swirling wind at hurricane force that did more than move some furniture. Many institutions are still “cleaning their ears” and for many investment portfolios, a “brown out” would be putting it mildly. It may be years before the domestic economy has its financial “hair” back in place.

Today, the wind continues to blow. Political winds have shifted and are perhaps shifting again as we all head to the polls. Predicting the shift of political winds is difficult, dangerous and frustrating for most. However, as investors, we must hone in on which companies have the winds at their backs and which are facing stiff headwinds given the current political environment. The financial services industry and especially the banking industry are currently facing the stiffest of headwinds. FDIC costs have soared; heightened regulation and weak loan demand are all weighing heavily on the profitability of domestic banks. Given the large loan defaults of the last few years, persistent high unemployment and new laws regarding fees on electronic transactions, most banks won’t see calm winds for many years.

Real estate is another industry and aspect of our economy struggling to hold its ground despite unrelenting squalls. Residential real estate has a large oversupply of homes that need to be worked through while commercial real estate has to survive the downsizing of companies across the country. Capital for real estate investment is more difficult to obtain for those who do want to borrow but for most investors, deleveraging continues while the return expectations of property owners have had to downsize.

Speaking of downsizing and deleveraging, the average consumer’s mission has become a reduction in discretionary spending. The retail industry, as well as the travel and leisure industries, in general are staring straight into the gale of such reductions. And although we don’t feel such impairment to the consumer is permanent, we see recovery to previous discretionary spending levels likely years away. Moving from a more discretionary industry to one that is at the heart of the political headwinds is the health insurance industry. Current legislation seeking to expand coverage to all Americans requires insurance companies to offer more benefits all the while restricting the price of those benefits.

Health insurance companies will find it difficult to maintain margins AND navigate the new legislative environment. Also within the health care industry and facing headwinds are the pharmaceutical companies; generic competition, the Food & Drug Administration, and pharmacy benefit managers have squeezed margins for many pharmaceutical companies so tightly it is leaving them little incentive to continue to develop new drugs. Conversely, the political winds are blowing in favor of some industries. Infrastructure, in general, is one such industry receiving funding from various government stimulus programs. Companies that have the scale, the experience and the technologies to win these contracts are experiencing the growth and the margin expansion that we demand from the companies that we own.

 Technology is another industry with a strong tailwind. Companies are being forced to be more productive with less, to automate and to improve their current offerings. Smart phones, digital media and healthcare technology are all strong pockets within the industry as we all work to increase efficiency whether we are at the doctor’s office or on the road. Speaking of being on the road, the Energy industry is another that is experiencing tailwinds. Higher prices stemming from increased global demand is helping energy companies to grow and prosper. Within the energy industry, clean energy is enjoying the strongest of the favorable breezes with political and environmental pressure building to find energy saving alternatives. Coupled with higher energy prices, the clean energy sector is likely to continue to experience prevailing winds for some time.

Knowing the direction and speed of various headwinds and tailwinds will continue to grow in importance for investors and for domestic corporations.

Headwinds and Tailwinds