Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Deflation
If 2007 was the year of inflation worries and stagflation nightmares, 2008 will be the year of deflation.
- Throughout 2007 the message from the Federal Reserve Open Market Committee has been relentlessly the same:
- "The Committee judges that some inflation risks remain." - Jan. 31, 2007
-"[T]he Committee's predominant policy concern remains the risk thatinflation will fail to moderate as expected." March 21, 2007; May 9,2007; June 28, 3007; August 7, 2007
- "[T]he Committee judges thatsome inflation risks remain, and it will continue to monitor inflationdevelopments carefully." Sep. 18. 2007; Oct. 31. 2007; Dec. 11, 2007 - Relentless.
- Infact, one has to go all the way back to February 2, 2005 for the lastFOMC statement that did not express concern about inflation.
- Andwe have to go all the way back to December 9, 2004 to find the point atwhich the Fed declared victory over deflation, or, as they prefer tocall it, "an unwelcome fall in inflation."
- Meanwhile, isn't oil a hair away from $100 a barrel?
- With the exception of the final six months of 2006, crude oil has risen almost without pause since January 2002.
- And isn't gold at a record high?
- Since May 2001 gold has risen from $260 to over $850.
- These are signs of inflation (or stagflation), not deflation right?
- A common misunderstanding is that falling prices causes deflation.
- No. Deflation causes prices to fall, falling prices do not cause deflation.
- Andwhile the price of crude oil, gold and other commodities has certainlybeen a trend followers dream, the trend is only your friend until theend.
- We have deflation right now, it's just that no one is talking about it.
- Adecrease in the supply of money or credit and a decrease in the demandfor goods related to the inability to access credit is a perfectdeflationary cocktail.
- You will know it in financialmarkets characterized by a rising dollar, falling interest rates, andultimately a declining stock market.
- Looking ahead, we will be talking about deflation by the end of 2008, not inflation.
2. Consumer Recession
It hasn't happened since 1991, but after 16 years prepare for a "consumer recession" to make headlines.
- Of course, this isn't exactly going out on a limb. We know that.
- Infact, according to an NBC News/Wall Street Journal poll, more thantwo-thirds of Americans believe the US is either in recession now orwill be in 2008.
- Now we're part of the crowd.
- The reason we bring this up is because the very act of labeling a "recession" is something that typically takes place as it is concluding.
- Thus,the opportunity lies not in the media's confirmation of what we alreadyfeel and know, but in recognizing the rear view mirror that willproduce those headlines.
- Bottom line: Once the recession is officially confirmed, we can begin to look for what will appear on the other side.
3. The Coming Cleansing
Granted, a common theme for every new year is "getting in shape,"and "kicking vices," etc. but I like the metaphor of this week's coverstory in Time Out New York, "Get Clean!" 
- It covers everything from ridding one's body ofantidepressants, religion, codependency, sugar, to being late and, ofcourse, the obligatory drugs and alcohol advice.
- Alas, there is no mention of financial "cleansing," but perhaps by June there will be.
- After all, deflation is simply the cleansing process by which malinvestments are liquidated and destroyed.
4. The Rush to Disassociate
Many social trends frequently begin in the creative class and work their way out to "regular" society, so the story below seemed interesting, a comedian taking heat for making money.
Click to enlarge
If the 90s were about wealth, accumulation and consumption, 2008will continue the mean reversion toward something altogether moreaustere, if not more sensible. Debt reduction and the rejection of(and guilt projection toward) materialism will continue what began in2006 and 2007 as meditations on not just doing more with less, butdoing less... period.
5. So, What to Do?
One thing I must make clear is that the economy is not the stockmarket. Inflation, stagflation, deflation, recession, depression,these are all interesting concepts and economic conditions, but thestock market is something else altogether; probably the reasoneconomists seem to make such poor stock market forecasters.
So the question now is, what do we do in 2008? Where will we find the winners and losers?
First, the areas I believe we want to avoid remain the Financials and Consumer Discretionarysectors. Both sectors as we enter 2008 are deeply oversold intechnical terms but, despite the potential for near-term rallies, therelative outperformance longer-term will come from other sectors.
What about Energy? As we noted in the first themeon Deflation, this sector has benefited for many years now from thenear-unwavering upward movement in crude oil prices. It's now theofficially "crowded" sectors. When we first began writing about the Energysector in 2002 it carried a paltry 6% weighting in the S&P 500 . Over the past five years it has more than doubled and now comprisesnearly a 13% weighting in the S&P 500.
This does not mean the secular trends benefiting Energy and Basic Materials is over. After all, in 1980 Energy and Basic Materials together made up nearly 40% of the S&P 500'sweighting; today they make up a little less than half that. It justmeans we may need to take a break from their outperformance for alittle while.
As 2007 marked the conclusion of the long-term outperformance cyclefor small caps, 2008 I believe will mark a continued turn toward largecap and defensive sectors. Among the ones I like are Healthcare and Consumer Staples.
Below are 7 stocks to consider from those two sectors:
CVS Corp. (CVS)
Groupe Danone, ADR (GDNNY)
Hologic (HOLX)
Magellan Health Services, Inc. (MGLN)
Pediatrix Medical Group (PDX)
Procter & Gamble (PG)
Reynolds American (RAI)
