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Utilities to Play Defense

Among our biggest concerns about the recent global market turmoil is that it could lead to further declines in stocks, a deepening in the commodities crash and a cycle of currency devaluations lead by China’s yuan. These are deflationary trends that could export overseas pain to the U.S. economy.

Deflation has been a worry of ours for a while.  More than two years ago, as the Fed announced its intent to begin tightening, I wrote that the central bank’s “removal of stimulus could set the stage for another deflationary spiral.”

And we noted last September, economist Carmen Reinhart’s paper found “the risk of the world economy is actually tilted toward deflation for the 23 advanced economies … even eight years after the onset of the global financial crisis.”  

Up until now, improvements in U.S. growth, consumer spending and employment have been offsetting global weakness.

But it’s hard to ignore the fact that the Fed is pretty much the only major central bank that isn’t currently in easing mode. Clearly, its peers are already worried about disinflation, if not outright deflation.

What much of the media seem to ignore when talking about China and other countries that devalue their currencies is the deflationary impact that such actions have on U.S. businesses. These moves can force U.S. firms to lower their prices to stay competitive with overseas products, and that erodes earnings and stifles growth.

That’s mainly why even as we have a Buy American theme, it’s only domestically-focused companies as multinationals are being hurt by a strong dollar. And we insist the domestic businesses have pricing power, such as electric utilities. 

If continued global weakness leads to deflation in the U.S., then utilities will be the best investment in such an environment.

A deflationary spiral is a vicious cycle where price declines lead to lower production, which in turn leads to lower wages and demand, which leads to further price declines.

Amid deflation, capital preservation is king, and utilities offer relative security and stable income. That doesn’t mean share prices of utilities won’t dip during a downturn, but it does mean that they do a far better job of holding their value, while continuing to offer a steady payout.

Even when consumers cut back on discretionary spending, they’ll still pay for to keep the lights on, the water running, and the media streaming.

 


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