Commentary: Educated Investor - The unexpected

Several months ago in this column I mentioned the fact that many downturns in an economy come from the unexpected. It seems investors and economists alike tend to focus on the obvious, but in the end it is the unexpected that is the villain and often the killer in a growing economy.

In my previous article I warned that China would be a factor in causing inflation here in the United States as well as in the global economy. Due to China's red-hot economy the cost of basic commodities has skyrocketed around the world during the last year or so. We have witnessed a worldwide rising cost for coal, copper, iron ore as well as oil.

In the past decade we have seen China go from an oil exporter to a major oil importer. China's increased consumption has placed a tremendous burden on the international oil supplies.

They alone are responsible for approximately 40 percent of the growth in global oil consumption since the year 2000. China is now the world's second largest consumer of petroleum. Until the Chinese economy slows there is no end insight for their insatiable appetite for energy.

Obviously, here in the states, we have felt the sting of rising energy prices as we have observed the dramatic rise in gasoline prices in the first five months of this year alone. The average price of a gallon of gas has soared from about $1.48 to more than $2 per gallon, a hefty 33 percent rise in an amazingly short period of time.

The rising cost of fuel will most likely become a major obstacle to our economic recovery.

Personally, while everyone else seems to be watching rising interest rates as being detrimental to our economy, I believe the unexpected rise in energy cost will have a far more reaching impact on our economy.

And of course, if you add the two together, rising interest rates plus costlier energy prices, I believe we will quickly enter another recession, often referred to in our case as a double-dip recession.

While rising interest rates will affect housing and much of our consumer spending, which is based on interest rates, increased energy costs will have a major impact on non-interest rate sensitive purchases.

For example, if it cost a family an additional eighty dollars a month to fill their gas tanks, the average hard-working individual will probably have to cut back on their discretionary spending.

In other words, less trips to the local McDonald's or Wendy's, or perhaps a family night out at the ballpark will be cancelled.

In some cases families might be inclined to cancel their Cable TV subscriptions for a period of time in order to balance the family's budget.

Possible trips between beauty parlor appointments will be lengthened. And of course summer vacations can be shortened or cancelled altogether. The consumer, which accounts for two thirds of our economy, spending less, surely will adversely effect our economy.

These are the types of activities that usually do not involve credit but are considered out of-pocket cash expenses. The ultimate result is the same.

Less consumer spending will eventually lead to a slowing economy and at the same time will suffocate our recent rise in employment. All of this will be due to the spiraling cost of oil and in the end higher gas prices at the pump.

When you add in heating costs for our homes, the situation only gets worse.

So what does all this mean to the investor? Once again, do not put faith in the obvious. Think outside the box.

Currently, the rising cost of energy is a much larger culprit than that of rising interest rates. Rising rates hurt people on credit the most, whereas, an increase cost at the pumps hurts everyone. Add the two together and you get devastating results.

As for investing, be careful of investments that are highly- energy related. For example, how much of the increased fuel costs can the airlines shift to the traveler before the passenger decides not to fly?

This possibility or predicament also means the hotel industry could be adversely affected as travelers remain closer to home.

The same could hold true for the restaurant industry as more and more families eat more cheaply at home. The trucking sector is also a potential loser as well as the express mail or the various overnight delivery services.

The point is, make sure that when you consider investing in a particular stock that you investigate how higher fuel prices might affect their bottom lines. If you determine rising fuel prices will affect a companies performance stay away from the stock.

Look for equity investments that do not rely on energy as a major cost factor. Research companies that can offer their customers productivity gains which can help offset rising energy cost as well as increasing interest rates.

Once you find companies that aren't dependent on fuel, look for companies that have low or no debt at all. This would be akin to killing two birds with one stone.

Therefore I would research stocks that offer goods or services that offer the end user productivity. I would also investigate to make sure the company does not rely on energy and if at all possible, little or no debt.

I would also suggest stocks that do well during periods of high inflation. If you so desire you can check my website for an article entitled The Big I for a few suggestions.

Anyway you look at it, this stock market calls for the greatest scouting when searching for solid equity investments.

David R. Clogg, ChFC is an account executive at Chapin, Davis. He can be reached at 410-435-3200 or visit his Web site at www.theeducatedinvestor.info.

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