Follow the Biggest Spender: the Government

All we hear is that the economy will pick up when consumers start spending again. This belief has obvious merit, since almost 70% of U.S. GDP is consumption. No one really knows when consumption will return to 2007 levels. With unemployment forecast to eclipse 8% by the first half of this year, it could be years before consumption stabilizes.

Americans have also learned a very valuable (and painful) lesson about the consequences of the excessive use of debt. Even when jobs and housing stabilize again, many consumers will likely spend more conservatively and use credit only when absolutely necessary.

But the economy must go on if our modern-day world is to exist. And it will go on because of the efforts of world governments, especially here in the U.S. By lowering the fed target rate to near zero, the U.S. has done in a year what Japan took nearly a decade to accomplish.

Right now, government spending is what will keep the economy slowly moving and eventually get it running smoothly again. The new administration has committed itself to stabilizing the economy by spending in order to create jobs and aiding the housing industry. By understanding government spending priorities, you can find securities that will benefit from it. And many of them are trading at prices that offer tremendous numbers.

The three largest spending categories of the federal budget are Social Security, defense and health care (Medicare and Medicaid). For the investor, his or her attention should focus on the defense and health care categories. Regardless of what rhetoric we hear every four years, the numbers speak for themselves.

• About 20% of 2007 spending went to defense (this includes operations in Iraq and Afghanistan). Of the $2.7 trillion spent by our government, this means that over $540 billion went to defense.
• In the last 20 years, health care's share of the budget doubled, reaching 27%, or $717 billion, in 2007.
• 80 million people were insured through Medicare, Medicaid and military health programs in 2006.
• The federal government pays one-third of the nation's medical bills. Over the last 40 years, many costs that individuals used to pay out of pocket have been transferred to the federal budget.

Indeed, if you examine the health of major health care providers such as WellPoint (WLP - commentary - Cramer's Take) or UnitedHealth Group (UNH - commentary - Cramer's Take), you will see that the fastest-growing segment of the business is Medicare and Medicaid enrollment. Ask any medical professional, and they will tell you the same.

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At the time of publication, Gad had a long position in KBR, although positions may change at any time.

Sham Gad is the managing partner of the Gad Partners Fund and the Gad Partners Offshore fund, value-centric investment partnerships based in Athens, Georgia. Gad has written extensively for the Motley Fool and was a securities analyst for UAS Asset Management, a small, value-focused fund in New York City in 2007. Previously, Gad managed assets for the Gad Investment Group. For additional information, please visit www.gadcapital.com.

Gad also runs a value-investing blog inspired by the teachings of Benjamin Graham and Warren Buffett. Additionally, he is currently working on a value investing book to be published by John Wiley & Sons in the fall of 2009. Gad earned his BBA and MBA at the University of Georgia. Send Sham Gad an email. You can reach Gad at [e-mail].