Expect a Shallow, Low-Inflation Recovery

• ByVincent Farrell Jr.,
• On 9:01 am EDT, Friday September 4, 2009

Lyle Gramley, Soleil's chief economist, recently wrote a piece about the first year of a recovery. He looked at nine prior recessions and found some interesting takeaways.

The average recovery for the nine rebounds was 5.8% in the four quarters following the end of the recession. When the recession was deeper (an average of -2.7% for five of them), the recovery was more pronounced and showed an average gain of 7.1%. When less severe (four recessions with an average decline of 1.1%), the rebound was milder at an average gain of 4.1%.

Net exports are usually a drag as the U.S. recovers more quickly than the rest of the world and inventory rebuild usually draws imports. Consumer spending is often a smaller part of a recovery than it would be for a normal economic period, but it's still critical.

The key to the consumer segment is wage growth. Since wage and salary income is below a year ago, and since the consumer is still stretched and is in a conservative frame of mind, Lyle believes the recovery will be muted. Inflation usually goes down the first year of a recovery, so interest rates will stay low.

His conclusion in one sentence would be to expect a shallow recovery with low inflation. With this scenario in mind, here are some stocks our analysts would focus on (in no particular order). For our complete analysis, including price targets and specific drivers, click here.

• Allstate : Our price target of $34 is based on a low 1.0 multiple of projected year-end book value excluding accumulated other comprehensive income (AOCI) or $35.20. In a shallow-growth economy with low inflation, Allstate should be a winner.
• Kellogg and Heinz : These food producers generate significant portions of their sales in areas outside the U.S., giving the companies better growth avenues if the U.S. recovery is slow. The companies' strong brands are a major source of strength.
• BB&T : The company's strong balance sheet should help it grow through acquisitions despite a lack of strong national/regional growth. Its strong fee income stream provides a stable base for revenue, offsetting credit costs in a difficult environment.
• Big Lots : The value-focused consumer will continue to drive traffic to this discount retailer, producing market-share growth in a contracting retail space. Big Lots faces easy comparisons, and the value proposition should stand out as industry inventories are more properly aligned with demand.
• CBS : Cost-cutting across all CBS divisions implies that as revenue growth turns positive with the economy -- more than 70% of CBS' revenue is from advertising -- EPS should beat estimates. We expect CBS to continue to exit noncore assets such as radio, publishing and outdoor, which would create an additional source of cash flow to repay debt or return to shareholders.
• Jo-Ann Stores : Wal-Mart's withdrawal from the fabric space is creating an $800 million sales opportunity; chief rival Michael's is leveraged due to its 2006 leveraged buyout and is focused on debt repayment. Potential for mid-single-digit EBIT margins could yield earnings power of $2.50 to $3.00.

Buzz up!