Morningstar Advisor - April/May 2010 - 40

Spotlight

Dominant China
How it could happen: Rebounding developed markets resume consumption of Chinese products. Meanwhile, the country takes steps to diversify its economy, including boosting domestic consumption, developing its own credit markets, and becoming the leader in new technologies. What investors can do: Buy the firms in China that will benefit from local consumer growth and that have the least government involvement: small caps (via Claymore/ AlphaShares China Small Cap HAO). U.S.-based high-quality companies that do business in China, such as Yum Brands YUM, Coca-Cola KO, McDonalds MCD, and Colgate-Palmolive CL, would also benefit. Unconventional approach: Avoid commodity funds. China has shown itself to be a very savvy buyer in the past few years (look at its import levels versus spot and futures prices through 2008–2009), so don’t expect China to drive up the commodity futures prices to staggering new highs. And the contango issue would be considerable as speculators who can’t take physical delivery pile in to try to get a piece of the China story.

Jones Oil & Gas Exploration & Production IEO; low-cost electricity providers, such as Exelon EXC and Enexus (the upcoming spinoff from Entergy ETR); and alternative-energy firms, which would be more competitive, via an ETF such as Market Vectors Global Alternative Energy GEX. Also, consider companies that enable efficient transportation of people and goods (see Berkshire Hathway’s BRK.B purchase of Burlington Northern Santa Fe BNI).
Unconventional approach: Telecommunica-

Unsustainable U.S. Deficit
How it could happen: A slumbering economy and an unwillingness by the government to either cut spending or raise revenue keeps deficits above 3% of the GDP—and at rates greater than the growth of the economy. Investors become skittish about the sustainability of the United States’ fiscal actions and stop buying debt at low interest rates. The U.S. government is forced to raise rates, setting off a chain of events including a decline of the dollar, inflation, and higher taxes. What investors can do: Rates elsewhere in the developed world and stable emerging markets would likely fall as reserve dollars and other low-risk investors flee the U.S. Treasuries market. This means that investors would not just want to own foreign bonds, but would want a longer duration as well (consider iShares S&P/Citi International Treasury Bond IGOV). The euro especially would be likely to benefit, as the excellent fiscal condition of core countries like Germany help keep overall deficits for the eurozone under control. Buy international companies not reliant on the United States, or high-quality, multinational domestic firms (such as Colgate-Palmolive CL, Coca-Cola KO, and Proctor & Gamble PG). Unconventional approach: Buy casino-gaming

tions firms. More and more information and entertainment will be delivered electronically, and telecommuting would gain in popularity to save travel costs.

Major Energy Innovation
How it could happen: New forms of energy— wind, solar, biofuel, geothermal, tide capturing—will be developed and made economically feasible as oil supplies decline and environmental concerns rise. What investors can do: Major innovation equals major disruption. Will an existing firm be the one that cracks the nut of cheap alternative energy? Maybe, maybe not. If not, nearly any energy-dependent or utilities stock would have a chance at being a big loser (except probably incumbent low-cost nuclear producers). Alternative energy companies currently lack moats, and most are overpriced. A better bet might be ultra-energyintensive industries, such as smelting, that would see their costs plummet with the new cheap energy source; consider Market Vectors Steel ETF SLX. Or look at travel and leisure names and consumer discretionary companies as nondiscretionary energy expenses fall. Unconventional approach: Buy small-cap energy tech firms, in case one becomes an innovation leader. Concentrate on the really small firms to get a bit more leverage.

Sky-High Energy Costs
How it could happen: World economies rebound, creating greater energy demand. Oil production declines because of the cost and difficulty of tapping into new reservoirs, tightening supply as demand rises. What investors can do: Buy exploration and production companies of all stripes or an ETF that does so, such as iShares Dow

companies. Expansion of gambling and associated taxes would be a politically palatable way for governments to raise money quickly.

Sovereign Debt Crisis
How it could happen: Crushing debt loads wreak havoc on developed countries around the world. Greece, Italy, Ireland, and Spain in the eurozone face a real risk of default, because they don’t control their own

40 Morningstar Advisor April/May 2010

Morningstar Advisor - April/May 2010

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