Jobless Recovery Would Call for Nuanced Investing

By JEFF D. OPDYKE The unemployed don't spend much. They do, however, brush their teeth and power their homes and seek medical care. And the companies that sell such products or services could remain attractive investments as the economy heads into what many see as a jobless recovery. The U.S.'s unemployment rate recently hit 9.5%, its highest level since the early 1980s. Many economists see it going above 10% and only slowly receding. They say an economic recovery won't inspire much hiring as companies grapple with slower economic growth, overcapacity in numerous sectors, and slack demand driven in part by a newfound saving ethic among overleveraged consumers. Double-digit unemployment, says Peter Gutmann, economics professor at Baruch College of the City University of New York, "could be with us for some time." A jobless recovery might not decimate the stock market overall since high unemployment limits wage pressures and keeps interest rates low. Low rates "are helpful for the P/E [price/earnings] multiples on stocks" because investors perceive better upside in equities than in safe, low-return Treasury bonds, says Richard B. Hoey, chief economist at Bank of New York Mellon. Investors accustomed to milder recessions in which consumer spending remained relatively strong may be in for a shock. Heavily indebted consumers are unlikely to resume spending for quite some time. That means investing in an era of high unemployment will be an exercise in nuance. Health-care spending should generally hold up since sick people will still seek medical care. Yet increasing unemployment brings larger numbers of uninsured patients, possibly leading to "the largest shift in recent U.S. history" of patients away from health-maintenance organizations and into the ranks of Medicaid or the uninsured, says Jason Gurda, analyst at Leerink Swann. That pinches HMO providers such as Aetna Inc. and Humana Inc. Unemployed, uninsured people will struggle to pay medical bills, and some will forgo elective procedures. Standard & Poor's analyst Jeff Englander has a "sell" rating on companies like AmSurg Corp., an operator of specialty hospitals, and a "hold" on community-hospital chain LifePoint Hospitals Inc. He finds better health-care plays in stocks like St. Jude Medical Inc. and Boston Scientific Corp., medical-device makers tied to nonelective care; and in stocks of skilled-nursing and long-term care facilities such as Kindred Healthcare Inc. and Sun Healthcare Group Inc., which benefit from an aging populace unaffected by unemployment. Retailing is equally bifurcated. Cash-conscious consumers are keeping their pocketbooks closed. That is troubling for retailers like clothier Abercrombie & Fitch and department-store chain Nordstrom Inc. that live on discretionary dollars. Low-price leaders such as Wal-Mart Stores Inc. and McDonald's Corp. could continue to hold up well. Share prices of the two companies are close to their market peaks. Even some sellers of discretionary products like clothiers Aeropostale Inc. and Buckle Inc. are hanging on to customers by aggressively lowering prices, says Brian Sozzi, analyst at Wall Street Strategies. David Kovacs, chief investment officer of quantitative strategies at Turner Investment Partners, likes consumer-products companies like Philip Morris International Inc., Kraft Foods Inc., Colgate-Palmolive Co., Coca-Cola Co. and PepsiCo Inc. -- all "businesses that supply what people need." And with consumers scaling back restaurant outings, low-price grocer Kroger Co. looks to be the "best-positioned supermarket," according to a recent research report from Andrew Wolf, analyst at BB&T Capital Markets. Banks would normally be heading into an easier environment, since low interest rates associated with a jobless recovery typically help banks boost profits. Yet heavily indebted consumers have little reason to borrow, and persistent joblessness raises the risk of more home foreclosures in a financial system already crippled by homeowners unable to repay mortgages. "We estimate another $1 trillion of losses in the next few years, and we see another big wave of foreclosures coming," says Barry Knapp, head of U.S. portfolio strategy at Barclays Capital. Regional banks will have it the hardest, Mr. Knapp says, in part because of their heavy construction lending, while banks like J.P. Morgan Chase & Co. "will be well-positioned for whatever kind of recovery we have." As the economy recovers, companies often employ temporary help before hiring full-time workers. Yet Jeff Silber, analyst at BMO Capital Markets, says that historically, companies like Manpower Inc., Robert Half International Inc. and others surge early, only to sink later. The BMO Capital Markets Staffing Index shows staffing companies typically hit their ultimate trough "just about the same time a jobless recovery ends," which is usually well after the economy has turned around, Mr. Silber says. Finally, Deutsche Bank chief U.S. economist Joseph Lavorgna says U.S.-based, export-dependent companies that sell into emerging markets "make a lot of sense" in a jobless recovery. That is because those areas of the world continue to grow at a faster pace than the U.S., and the expanding consumer base there remains relatively healthy and unencumbered by debt. Companies that stand to benefit include firms such as Honeywell International Inc., United Technologies Corp. and Tyco International Ltd. Write to Jeff D. Opdyke at jeff.opdyke@wsj.com