Federal Reserve Chairman Ben Bernanke gave us a choice this week: A debilitating recession or destructive inflation. You decide.

We vote for recession. Bernanke, however, opts for inflation.

We shrug. So does Mr. Market. The Dow tumbles. Oil surges to a record $102.59. Gold jumps $15.50, to $970. Wheat, cotton, rice and corn follow suit. Before long, the dollar menu at McDonald’s will require a Jefferson, instead of a Washington:

Meanwhile, Americans keep lining up for unemployment insurance. The Labor Department reported that new applications for unemployment insurance benefits rose 19,000, to 373,000, last week.

It gets worse. More than 405,000 homeowners lost their homes to foreclosure last year. The Pentagon strategically braces for $225 oil. Drivers are paying 19 cents more per gallon than they did just two weeks ago. Some experts think the price will go to $4 before the summer comes.

“You’re adding an oil shock on top of a crunch on credit and a housing collapse,” said Nigel Gault, an economist at Global Insight. “Even the U.S. economy cannot withstand all of that at the same time.”

So how will John Q. Public pay for a Happy Meal? We’re not sure.

But the day of the American consumer keeps fading wistfully into the night.

So what does that mean for you, dear reader?

We believe investors should be very cautious of stocks reliant on American consumers. We suggest you take special note to exercise caution regarding companies like Apple, Starbucks or P.F. Chang’s China Bistro.

We have no particular prejudice against any particular one. In fact, I work on an Apple, drink Starbucks and eat at P.F. Chang’s. Sometimes I do all three simultaneously.

However, if John Q. Public lost his house and credit card, we imagine he’d use his last $20 to buy toilet paper, Folgers and a pack of smokes.  He’s not going to make another dinner reservation on his 2008 iMac while sipping a $3 cup of joe.

Furthermore, these companies aren’t cheap:

As for what to buy, ask yourself: Can a company raise prices?

Think of things you need. Beer and cigarettes come to mind. Well, you may not need these items, but I’ll use them to illustrate a point.

When’s the last time you actually looked at the price of one beer versus another? I’m not talking Heineken versus Pabst Blue Ribbon, mind you. I’m talking about Heineken versus Corona…or Bud Light versus Miller Lite. Customers in this sector buy on preference. And they buy a few more cases when the price is cheap.

One could make the same case for shampoo and bandages. The point: When times are tight, we’ll still continue (hopefully) washing our hair and binding our wounds.

You also want to ask yourself: Can a business control its basic costs? When 1.2 billion Chinese start demanding a protein diet, can P.F. Chang’s easily pass on its input costs (higher meat prices) to a cash-strapped consumer? Will margins suffer?

In the case of a discretionary item like traditional Chinese cuisine, the switching costs are very low. In this business, consumers have many choices. Reprising the menu could easily suppress demand. That’s one reason we avoid the restaurant sector. Restaurants don’t possess a very good (if any) economic moat.

On the other hand, comapies that own tangible assets, base metals or natural resources should prosper. Companies well positioned to service the world’s immedaite need for infrastructure should also do quite well.

That’s one reason we made the case for a Mexican cement producer in Free Market Investor.

We believe it has been unfairly punished as a “housing sector” stock.

First, the company’s revenue stream isn’t as dependent on American sales as sellers seem to think. It boasts operations in more than 50 countries across five continents —diversifying the income stream enough that a slowdown in any one particular country shouldn’t affect the company all that much.

Furthermore, public construction — particularly infrastructure projects such as streets, highways and bridges — not housing, represented the most cement-intensive sector. Infrastructure accounted for 47% of total U.S. cement consumption in 2006.

So when housing construction was at its peak, infrastructure still stole the show. We expect this trend to continue. Analysts estimate that worldwide infrastructure spending over the next 23 years will require $41 trillion — a figure roughly equal to the 2006 market capitalization of all shares held in all stock markets in the world.

Our advice: Sell the Apples and buy the basic needs…

Until next time,

Christopher Hancock
February 29, 2008

Christopher Hancock

Christopher Hancock lives and breathes emerging markets. He travels extensively and utilizes his contacts across the globe to recommend the best international investments in the world. After working with Citigroup in Hong Kong on the challenges and opportunities associated with the forthcoming RBM flotation reform, Christopher left many of his friends behind and decided to return to the States to pursue a career in equity research.

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