Whether you realize it or not, the current economic expansion is close to making history. Having begun in June 2009, following the steepest recession this country has seen in more than 70 years, the current expansionary cycle just completed its 109th month. If the U.S. economy manages to continue expanding all the way through next July, it’ll top the 120-month economic expansion that led up to the dot-com bubble as the longest ever.
Then again, anyone who’s been invested in the stock market for any extended period of time is probably aware that the U.S. economy spends for more time expanding than contracting. Since the end of World War II, it’s been expanding in 86% of all months, leaving little room for pessimists to make a buck.
Investors would be wise to avoid investing in these industries
However, historical data provides irrefutable evidence that another recession is inevitable. No matter what the Federal Reserve does policy-wise, we are going to see another economic contraction at some point in the future. In fact, it’s probably not too far-fetched to consider the U.S. economy at the latter end of its current expansionary cycle.
With this thesis in mind, there are three industries I believe investors should avoid like the plague for the foreseeable future.
Despite being relatively inexpensive from a valuation perspective at the moment, I would strongly suggest not putting your money to work in the residential construction industry.
The most logical reason to avoid homebuilders is that the Fed is currently in the midst of a monetary tightening cycle. Not only is the Fed eyeing roughly three to four quarter-point (i.e., 25 basis point) increases to its Fed funds target rate in each of the next two years, but inflation has begun to pick up. Data from the Bureau of Labor Statistics in June showed that the Consumer Price Index for All Urban Consumers rose 2.9% on an unadjusted basis over the last 12 months. If inflation continues to rise, it could coerce the Fed to get more aggressive with rate hikes.
The issue is that these rate hikes tend to put upward pressure on mortgage rates. While the effect isn’t perfectly correlative, higher interest rates tend to lift Treasury yields, and the mortgage lending market usually takes its cue from the 10-year Treasury bond yield. In plainer terms, we could be looking at the highest mortgage rates we’ve seen in close to a decade within the next two years. With the 30-year mortgage currently sitting at 4.6%, it’s only a stone’s throw away from 5%, which was last hit in February 2011.
This is bad for homebuilders for one simple reason: Consumers have been spoiled with historically low lending rates for more than a half-decade. If rates rise, we could see mortgage applications and ownership interest tumble.
Let’s also not forget that the Tax Cuts and Jobs Act trimmed the mortgage interest deduction cap by $250,000 to a new maximum of $750,000 instead of $1 million. That’s less incentive for consumers to buy a first or additional property.
The name I’d specifically avoid here is Hovnanian Enterprises (NYSE:HOV). Despite focusing on the middle-income market, Hovnanian’s second-quarter results contained a number of red flags. For instance, its consolidated average home price sold fell by 1.9% year over year, with sales in California (often a precursor to housing industry direction) sinking by 7.5%.
Hovnanian’s homebuilding margins are also subpar relative to the largest builders in the industry. This should result in ongoing losses for a company that’s been unable to right the ship since the Great Recession.
Weight-loss service providers
Companies that provide weight-loss meals or services are also worth avoiding, although you wouldn’t think that by focusing on their recent quarterly results or stock performances.
Weight Watchers (NYSE:WTW) wound up reporting a nearly 20% increase in net revenue during the second quarter, with net income rising almost 57%. The company credited a 27.6% increase in year-over-year subscribers, as well as those subscribers sticking around for a longer period of time, for its improved results.
Meanwhile, Medifast‘s (NYSE:MED) share price has tripled since the beginning of March. Medifast’s second-quarter operating results showcased a 55% increase in sales and an 84% improvement in year-over-year adjusted earnings per share. A substantial increase in Optavia-branded products sold, along with a big jump in active earning coaches, drove results. The company also substantially lifted its full-year sales and profit guidance (close to 20% at the midpoint for both measures).
Still, evidenced by what happened during the dot-com bubble and Great Recession, discretionary spending on weight-loss products and services is one of the first expenses consumers jettison when trying to pare down their spending. Again, I’m not trying to predict when the next recession will arrive so much as suggest that when it does come around, weight-loss providers will likely be among the first to be hit.
Interestingly enough, Weight Watchers cratered by 15% after its second-quarter results listed above for only one reason: Its subscriber count fell by approximately 100,000 from the sequential first quarter. This is an industry that struggles with customer and brand loyalty, and a decline in subscribers for Weight Watchers can’t be overlooked.
As for Medifast, even with its stellar results, investors have seen this story play out many times before with the company. Now valued at a forward P/E of 36 and 24 times book value, you’d think this was a tech stock. Rarely do metrics like this hold up in the highly cyclical weight-loss space.
I’d slot in Weight Watchers and Medifast as two names to resolutely avoid.
Finally, if you believe we’ve entered into the latter part of our economic growth cycle, it’d probably be a good idea to avoid casual-dining restaurants.
Back in June 2014, a “Beyond the Numbers” report from the Bureau of Labor Statistics (BLS) examined consumers’ behavior toward food in the boom environment of 2007, then the subsequent post-recession environment (2011) and recovery (2013). What the report showed (as expected) is that consumers tend to eat more at home during and after a recession; or, should they eat out, they prefer limited-service restaurants, such as fast food. In other words, full-service casual-dining restaurants take it on the chin when recessions strike.
What’s particularly notable about this BLS report is that the ratio of full-service restaurant food to limited-service restaurant food didn’t rebound during the latest recovery. As of December 2013, the ratio was still falling, which suggests that the Great Recession may have irreparably changed the dining habits of consumers. This isn’t to say that casual-dining restaurants are going the way of the dinosaur so much as to suggest that it could become harder to stand out. That challenge would be magnified if consumers rein in their spending.
The casual-dining restaurant stock I’d most suggest avoiding in this industry is Bloomin’ Brands(NASDAQ:BLMN), the parent of Outback Steakhouse, Carrabba’s Italian Grill, Bonefish Grill, and Fleming’s Steakhouse.
Bloomin’ Brands is already having problems in the “boom” environment. Revenue has fallen in each of the past three years, and 2018 looks to extend that streak to four. Likewise, operating margin has eroded since 2015, with the company using promotions and discounts to drive consumers through its doors. Higher inflation, especially food inflation, will only weigh further on its margins.
What’s more, Bloomin’ Brands’ restaurants struggle to engage consumers and keep them loyal to the brand. As reported by Nation’s Restaurant News, a 126-restaurant study on brand loyalty scores found that Carrabba’s, Outback, and Bonefish ranked just 25th, 41st, and 47th, respectively. While things probably could have been worse, understand that this list was also composed of fast-food restaurants, which aren’t known for motivating consumers to come back with their service.
In my opinion, adding this stock to your portfolio now would be a bloomin’ bad idea.