Bernanke’s acknowledgement of a future recession worries many on the street but it also provides the chance to get into several major deep discounters.  Deep discounters such as Big Lots and Family Dollar surge when economic news gets worse.  When people make less, they flee to these two stores for big savings on items.

Just as the housing bubble helped grow Target’s middle to upper class customer base, an ongoing recession will do much to line the pockets of Big Lots and Family Dollar which buy merchandise in bulk for dirt cheap to turn around and sell again for much lower than competitors.  These two companies are known for their low income customer base and benefit when the economy looks less than par.

Both these companies have a strong branding image and are known for their low prices.  Both stores offer brand name products with a much lower price than can be found at stores like Target or even WalMart.  The companies benefit by buying product that is overstocked and take in merchandise from other stores that might be out of season.   The loss of other retailers quickly becomes the gain of deep discounters.

I like deep discounters much more than regular dollar only stores because they have the ability to negotiate prices.  A dollar store that switches to a deep discounter usually faces tough marketability as consumers lose interest as prices rise.  Deep discounters are not as prone to losing money when the dollar falls, as the dollar loses value, the dollar only stores must cut the amount of their product or raise prices.

Big Lots reported very good earnings last quarter and set high marks for the next year.  The company has seen steadily increasing business as consumers look to cut costs by shopping at the deep discounter.  Biglots trades near its lows in share price at a tiny PE ratio of 14.  This kind of value is rarely seen even in deep discounters, especially with such high growth rates.  A PEG ratio of .7 is comforting that the company will continue to grow even amidst an economic downturn.

Family Dollar is another strong stock with much room to improve.  When the downturn of 01-02 came, Family Dollars stock moved up to the upper $40s to settle at record highs.  As you can see, this company proves to be very solid in periods of economic downturn and fluster as the market stabilizes.  Currently the stock trades at $21.40 per share, about the same price it traded before the internet bust.  This one trades even cheaper than  Big Lots at a PE ratio of 13 but has a much lower growth rate than Big Lots at a 1.26 growth rate.  Either way, if history repeats just like it did during the internet bust, this company is set to boom.

Beating the market in a downturn is much easier than in an upturn.  If the economy follows through with expectations, both companies can expect higher earnings and better than expected growth.  Both brands are known for their low prices on brand name products.

Last year brought much news about the USDJPY carry trade, or holding a trade merely to gain interest.  At the time, the Japanese lending interest was far below the borrowing interest paid by US banks, investors could simply borrow in Japanese yen to deposit into US accounts and make money on the interest.

Carry trades are usually highly leveraged, forex accounts allow up to 400:1 leverage at some brokers.  This kind of leverage allows an individual to control $1,000,000 in currency with just $250 down.  This kind of investing is very dangerous and also compounds the effect when the markets turnover, or the trade becomes unprofitable for carry trade investors.

The dollar faces a critical problem, at this point the Federal Reserve Board is pushing rates so low that it may soon be privy to being the new carry trade currency.  This has already happened with the Eurozone and the pound as the dollar is now pushing low interest rates that are a few points lower than the central bank rates in other countries.  This creates unnecessary selling pressure when investors go to sell dollars and buy other currencies to profit from the interest rate difference.

When the USDJPY carry trade broke down, investors quickly bought back Japanese Yen to cover positions.  This caused the yen to advance by 20% in 2007.  As rates were lowered and investors lost confidence, the dollar was sold to buy yen which moved the exchange rate from 120 yen to the dollar to less than 100.

This puts a daunting strain on an already hurting US Dollar.  If the same carry trade that perpetuated with the yen persists in the opposite direction with the Euro and GBP, the value of the dollar will continue to slide.  In this kind of position, investors borrow dollars to deposit in Euro banks.  This puts artificial selling pressure on the value of the US Dollar, causing it to correct.

Further action by the Federal Reserve to cut interest rates will only hurt the dollars value, pump up the price of commodities and cause a dollar sell off in favor of other currencies.  The difference between interest rates is still tight, but a further move of 50 or 75 basis points will be the beginning of a large, multi-year carry trade.  We’ll have to see how the Fed responds, surely they know that further action will create a large difference in interest rates and more selling pressure.