Big industries -- aluminum, autos, steel, memory chips -- are awash in excess global capacity, with more scheduled to come online. (I've described the problems in some of these industries in recent posts such as "Ford's dilemma" for the auto industry and "Alcoa delivers bad news for global profits" for the aluminum industry.)
Because the world hasn't begun to address the problems of excess capital and the excess production capacity that it creates under today's economic rules, the global economic recovery is going to turn out to be extraordinarily profitless in industry after industry as producers with excess capacity cut prices in an effort to buy market share.
This isn't a short-term problem. With the Chinese economy outpacing others in recovering from the depths of the downturn, China's "solution" -- flood the economy with cash, build plants and export the excess -- has become a model to emulate. The mismatch between global supply and demand in many areas of the global economy will go on for years, and in some sectors the excess of supply over demand will get worse before it gets better. (I spelled out the way that China's economic model contributes to this problem in my previous column on MSN Money.)
The problem is too big and too long-lasting to ignore. So what are investors supposed to do about it?
How about building a portfolio that avoids niches, industries and sectors where global overcapacity will create a profitless recovery?
Well, duh! Of course. Simple.
How about some advice on what to avoid and where to put money to work? Sure, like most advice -- such as "Never put anything smaller than your elbow in your ear" and "Buy low and sell high" -- it isn't very useful without specifics.
3 points of protectionI'm going to start with three sectors that you should target now and in the next few years that will avoid the worst of these problems. (I'll even throw in a glancing reference to a niche or two that has the characteristics you'll want to buy.) And I'm going to end by identifying three stocks that you should own (one is already in Jubak's Picks, one is in the Jubak Picks 50 portfolio, and one is a new buy) from one of these sectors.
To avoid the trap of excess capacity killing even modest profits, I think you have to look for sectors that have barriers that prevent excess capacity from driving down all prices as companies slit each other's throats to acquire profitless market share.
I can think of three big barriers like that:
1. Brands. In markets where consumers are willing to pay for a brand, the brand provides protection from excess capacity running prices so low that the producer can't make a profit. This isn't some new intellectual breakthrough on my part: It's right out of the Warren Buffett playbook. It's why he owns brands such as and . Because of their brand names, American Express is able to charge more for its cards, and Coke sells for more than no-name sodas (the ones my dad used to buy).
Unfortunately, there are fewer and fewer brand names that can withstand the onslaught of excess capacity. Cereal brand names such asare losing the pricing war to store brands. , another Buffett holding, has lost the news and ad battle to the excess capacity of the Internet. (Frankly, I think Buffett owns the Post company these days for its Kaplan testing and electronic education business.) Look at your own buying habits: How many brand names do you pay extra for these days?
Give me access to cheap capital, and I can be turning out Jubak's Cola -- "The cola that talks back" -- within a year and undercutting Pepsi and Coke on price. But getting the stuff into stores? That's the work of consistent investment running into the billions over a decade if you hope to compete with the system that putssodas, juices, water and Frito-Lay snacks into every store from Buffalo Gap to Beijing.
Sure, you can make a cheaper tractor thansells -- lots of companies do, and more are trying -- but Deere's network of service centers and dealerships has been crafted over decades. is able to eat competitors alive every day not because it sells stuff for less but because it has a purchasing and distribution system that lets it sell stuff for less and still make a five-year average gross margin of 24.5%. And the company never stops honing this competitive weapon. If I were a Wal-Mart competitor, I'd be up late almost every night worrying about news that Wal-Mart is going to increase the percentage of the goods it sells that it buys straight from manufacturers.
Investors are fortunate right now to have two areas of the technology sector that are showing solid growth and that present significant barriers to the destruction of profits by global excess capacity. One is the next generation of networked information technologies. Desktops and laptops, storage devices and even, increasingly, servers themselves are on their way to becoming technology commodities (if they're not there already -- have you priced a desktop lately?) where profits get crushed by global excess capacity., for example, has run into this global buzz saw.
But networked technology -- servers, storage, communication devices and software -- that connects as a unified system with the cloud of computing that increasingly is the Internet, that's not a commodity. That's because getting all this stuff to work together requires building not just a product but a system of suppliers and subsuppliers that can provide compatible pieces. And a service organization that can make sure that it all connects securely.
In a recent report, Forrester Research called for a six- to seven-year cycle of spending on what it calls the new information technology foundations for unified computing. Global spending on information technology, which fell 9% in 2009, is expected to climb 8% this year.