Editor's Note: This article is an updated version of the one originally posted on September 14.
The news just keeps getting worse and worse. Unemployment is bordering on double digits with 9.6% of the population out of work. GDP growth has been tepid at 2.4% and is expected to be even lower next quarter. Employee wages minus inflation have been stagnant for the past forty years. Many economists have recently increased the likelihood of a double dip recession taking place. Many individuals are trying to figure out how to invest in the face of such terrible data and rising uncertainty. Here are five sectors that tend to suffer in a market crash, and that you should avoid if the market starts heading for another dip. (For more financial news, see Water Cooler Finance: Mergers, Hostile Bids And SEC Probes.)
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The alternative energy sector is one of the best sectors to be in during market booms and one of the worst industries to be in during market crashes. High-flying stocks like First Solar (Nasdaq:FSLR)soared to over $300 during the market top as investors continually pumped in money hoping to pick the next big energy investment. Capital funding for the alternative energy sector has dried up as investors are avoiding speculative ventures.
During the market crash, shares dropped to $92 as investors fled from this alternative energy company to safer energy plays like Exxon (NYSE:XOM). That's a 70% drop - far greater than the stock market's 50% drop.
No sector is more affected by consumer confidence than the retail sector. When people feel bad about the economy, they consume less and save more. Lower rates of consumption directly impact department stores. People may keep shopping at Walmart (NYSE:WMT) and Target (NYSE:TGT) during tough times but they will stay away from the Macy's (NYSE:M) and Nordstrom's (NYSE:JWM). The consumer is weak and has not returned to their shopping habits pre-2008. People are not exactly likely to go out and splurge on a whole new wardrobe when they are worried about their employment status. Things were so bad at Macy's during the crisis that investors worried about a potential bankruptcy for the retailer.
Retail stocks have some of the worst balance sheets in the whole stock market. They are leveraged to the hilt with huge amounts of debt and large amounts of inventory. Linens & Things, Kohl's (NYSE:KSS) and CircuitCity (OTC:CCTYQ) all crumbled during the last market drop. Macy's shares plummeted 80% from $25 to $5 during 2008. (Find out what sectors outperform in hard times. Check out Industries That Thrive On Recession.)
Casual dining rises and falls based on the willingness of customers to spend money eating out. Dips in the Dow Jones lead to much lower foot traffic for casual dining chains. Casual dining chains are a lot more susceptible to economic downturn than quick service restaurants. Restaurants like the Cheesecake Factory (Nasdaq:CAKE)
saw their same store sales decline sharply during the last market drop. The stock dropped from the mid $20s to the $5 dollar range as a result.
Why is this? To put it simply, people find it way too expensive to eat out during recessions. Sure they may go to McDonald's (NYSE:MCD) or Wendy's (NYSE:WEN) but they shun restaurants like the Cheesecake Factory. Visits to casual dining chains were down 3% through the second quarter. Why pay $25 dollars for a meal when you can get one for $5 bucks?
CNBC, Bloomberg and financial television stations judge the health of the economy by the level of manufacturing production. Stocks rise and fall based on the activity in the ISM manufacturing index. Any correction in the stock market means that there has been a contraction in industrial production. Caterpillar (NYSE:CAT) is at the center of United States manufacturing. The company provides manufacturing, construction and mining equipment to companies around the globe. When industrial production slows down, no one is looking to buy construction equipment and Caterpillar suffers.
The U.S. construction industry is at its lowest level in a decade. Construction outlays sank to the lowest levels since July 2000, when they were $783.8 billion. Construction companies, homebuilders and equipment makers still have not recovered from the market drop of two years ago. At $70 a share, Caterpillar is trading as if construction activity is back to normal levels and not at lows for the decade.
Automobile purchases are driven by consumer confidence in the economy. The last economic dip drove Chrysler and General Motors (OTC:MTLQQ) into bankruptcy and drove Ford (NYSE:F) to the brink. Do you remember when Ford was burning through billions in cash every month? The stock was trading for $1.43 and was headed for the pink sheets. When the government offered assistance to the auto sector through government loans and programs like Cash for Clunkers, shares of Ford surged to the low teens.
Now that the government support is gone, auto sales have slowed. Last month sales were the worst that they had been for auto sales in the U.S. in the month of August in 28 years. No governmental stimulus means no auto sales. Companies in this sector could see a lot more pain ahead if there is a pullback.
The Bottom Line
As you can clearly see, sectors that depend on the consumer spending will experience the most pain during a market crash. Investors abandon these sectors during downturns for the safety of defensive stocks that are staples of everyday life. (For related reading, check out 4 Tips For Buying Stocks In A Recession.)
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