Why The Best Market Indicator Around... Is A Fast-Food Stock

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When interpreting the tea leaves of the economy and the market, economists, money managers, analysts and most garden-variety market pundits consult the same set of widely used economic indicators.

The S&P/Case-Shiller home price indices. Various purchasing managers' indices. An array of employment reports.

All of these are good, tangible indicators about the health of the overall economy and the direction of the markets.

However, I've found a widely held stock that indicates the health of many different indicators -- from commodity costs to wage inflation -- and often foreshadows how the broader equity markets will behave.

I look to the Golden Arches.

What the stock tells me is much more than how many burgers and fries Mickey D's has sold.

Including revenue from franchised outlets, McDonald's (NYSE: MCD ) boasts annual sales in excess of $30 billion, which would make the company the world's 68th-largest economy (just ahead of Ecuador). Let's look at the two most important components of McDonald's business and enable it to serve 1% of the Earth's population every single day: materials and labor.

In terms of materials, McDonald's uses 1 billion pounds of beef a year -- in the U.S. alone. That's equal to 5.5 million head of cattle. As commodity prices rise and fall, the company's input costs will shift and based on the size and scale of its consumption, those shifts will always play a major part in the performance of the business and the stock.

In terms of labor, McDonald's hires around 1 million workers in the U.S. every year. Based on company estimates, 1 in every 8 workers in America has been employed by the company at some point.

Factor in other important elements -- such as the company's use of paper products, transportation, real estate, store remodeling, even injection-molded plastic (McDonald's is one of the world's largest toy sellers, accounting for 20%, $6 billion-plus, of all annual sales) -- and it becomes clear that the stock is a pretty good economic and market indicator.

Here's a chart of MCD's performance over the past five years, along with that of the S&P 500 Index:

Obviously, investors who held MCD shares clobbered those who drank the indexing Kool-Aid over the past six years.

More importantly, look at the trend: Just a few months before a broader market pullback, MCD experienced its own pullback.

Each time the stock was weak, the culprit was rising input costs (inflation), which led to menu price hikes, labor concerns or softer sales (which in turn signaled weakening consumer spending) -- all clear economic indicators.

Now what was the average S&P pullback post MCD pullback? Around 8%. Hmm.

So what is McDonald's telling us about the economy and the market now?

The same thing it always has: Inflation is creeping into the picture... which will make for a weak market once it's fully realized.

Currently, MCD is off about 2% from its recent high near $103. While McDonald's is a great stock to own for the long haul -- preferably on a pullback well below $100 a share -- in an environment where rising inflation and valuation sensitivity could be factors, there is a handful of names that I would rather hold -- like these three blue chips:

AT&T (NYSE: T ) : The nation's leading wireless provider is busy expanding its reach with its announced acquisition of satellite content deliverer DirecTV (NYSE: DTV ) . Telecom has evolved from a lumbering, infrastructure-heavy utility with low growth and margins into a lean business with high margins and steady growth -- and AT&T is one of the best out there. Shares trade at around $35.50 with a cheap forward price-to-earnings (P/E) of 13.4 and an inflation-fighting dividend yield of 5.2%.

Cisco Systems (Nasdaq: CSCO ) - As a companion piece to AT&T's "railroad," Cisco is busy supplying the rails, ties and switches that help connect the Internet of Things. With well over half of the world's market share in routers and switching and 10 year average earnings per share growth of 12%, this perennial favorite is a bargain near $25 with a forward P/E of 12.2 and a rising dividend yield of 3.1%. Again, technology isn't necessarily inflation-proof, but it does hold up better than some sectors.

Alliance Bernstein Holdings (NYSE: AB ) : The master limited partnership ( MLP ) units of this asset manager have always been a go-to name for me when looking for portfolio income and growth. With a solid, research-driven money management franchise, earnings per share ( EPS ) are expected to grow 11% this year. With a price near $26, AB's dividend currently represents a 6.1% yield.

Risks to consider: While there is strong anecdotal evidence for this "McDonald's indicator," all factors regarding equity market behavior and influences should be examined and weighed before making any decisions on portfolio adjustment. Also, all three names discussed carry their own economic risk baggage within their respective sectors.

Action to Take --> Clearly, the pre-market correction pattern of MCD shares is interesting. With this in mind, it's probably a good idea to at least review your portfolio and consider managing risk where applicable. T, CSCO and AB have an average forward P/E of 13.5 and average dividend yield around 5%. The low valuation and higher yields will provide some protection from market volatility caused by rising inflation. Should inflation prove not be a problem, this group of stocks could have a total return upside of close to 30%, assuming a modest expansion of the forward P/E to 16.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: MLP , EPS

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