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In a recent post, we talked about the difference between investors and traders, and everything in this post will apply to investors. That is to say, the content of this post applies to people interested in a longer term position in stocks of three or more years. With the historic bull run that the United States stock market has been on since 2010, we all knew the day was coming where a negative catalyst would ultimately end the party. Not only is COVID-19 a disruptive presence for the markets, but also a global disruption like we have never seen before. Most, if not all, major industries have faced some sort of setback all across the globe.
The markets have remained relatively stable given the circumstances. However, officials in the often overly optimistic Trump administration are even projecting the unemployment numbers that could rival the Great Depression. Additionally, some are projecting up to 17% of small businesses could go under. With these seismic economic changes, it is likely the full damage of COVID-19 has not been realized by the markets. Consumer habits will most certainly change in the short term, and to some extent, for a lifetime.
What is an Inferior Good?
According to Investopedia, an inferior good is an economic term describing an item that has less demand as people’s incomes rise. For example, if your income is higher, you might prefer to grab your morning coffee at Starbucks. If your income is lower, you likely prefer to save some money and get it at fast food restaurant or the local convenience store. Instant noodles, frozen dinners, and canned goods are all examples of inferior goods.
So how does this all relate to investing? Just as demand for inferior goods decreases when income rises, the opposite is true when income decreases. As many Americans will need to watch their finances more closely, the demand for inferior goods will likely increase over the next few years. This is typically the case in any recession. We will look at the performance of two stocks that sell “inferior goods” compared to the Dow Jones Industrial Averages and S&P 500 in the last recession era.
Performance of Dow Jones & S&P500 2008-2010
So, let’s say that right now we are at the equivalent of October 2008. The United States economy essentially began to shut down around March 15, 2020. Lehman Brothers collapsed on September 15, 2008 and that’s essentially when everything got very real and sentiment greatly shifted in the mood of the public in the United States. So, we are about a month and half out of the initial shock of the economy closing down.
On October 29, 2008 the DOW Jones closed at 8,990.96, by September 15, 2010 (roughly two years after the initial Lehman Brothers shock) the DOW closed at 10,572.73, giving a hypothetical investor at 17.6% return, certainly not bad as we entered a major bull run. Putting the S&P 500 to the same test, on October 29, 2008, the S&P500 closed at 930.09, by September 15, 2010 it closed at 1,125.07, yielding an impressive 20.9% return on the road to recovery.
Let’s put two individual “inferior goods” stock picks to this test, McDonald’s and Dollar Tree.
On October 29, 2008, McDonald’s closed at a price of $57.18, two years after the Lehman Brothers collapse on September 15, 2010, it closed at $74.71 giving an investor a 30.6% return, a significantly higher return than the DOW Jones and S&P 500. How has McDonald’s performed since 2010? As we mentioned in a post on McDonald’s earlier this year, the stock has mostly performed remarkably well and has remained consistent. It closed on April 29, 2020 at $189.75 which would yield an investor a return of 151% over the last decade. This is even coming off the COVID-19 outbreak and a CEO being scandalously dismissed in late 2019.
There are no guarantees in the markets, of course. There are some concerns about disruptions to the meat supply chain that are being reported as a possible headwind for McDonald’s. However, with unemployment numbers far from their likely peak and heavy economic uncertainty, McDonald’s will likely be a place many more Americans will be spending their money over the next year or two as they turn toward “inferior goods.”
Put to our test, Dollar Tree closed at $12.84 on October 29, 2008. By September 15, 2010, it closed at $24.03. This is an impressive 87% return in less than two years. Dollar Tree’s momentum has continued to soar over the last decade. The stock closed at $80.86 on April 29, 2020. From that September 2010 timeframe to present, that is a 236% return. Again, with the economic uncertainty ahead, you may see more people changing spending habits and turning toward Dollar Tree and Family Dollar, which is also a company holding.
Again, there are risks involved with Dollar Tree as well. The company has indicated that the troubled trade relations with China and the United States have hurt its bottom line. However, the company has committed to finding new places to source their supply chain.
Obviously, navigating uncertainty is part of investing, but basic microeconomic theory notes that if we are indeed moving toward a recession, these “inferior goods” will likely be in demand as consumer income decreases. The performance of these two companies over the long term is also encouraging and make them potentially worth a look.