by Jamie Dlugosch | November 17, 2011 12:49 pm
A recent TV ad for Dos Equis Mexican beer implores Americans to “Stay thirsty, my friends.” To individual investors, I say, “Stay safe, my friends.”
According to the San Francisco Federal Reserve, the odds of a U.S. recession in 2012 are at 50%. That’s a pretty hefty percentage — and it shouldn’t be ignored. The stock market has been in full rally mode, weaving a web that might very well be a trap.
If the economy does slow, stocks are likely to retest the lows and aggressive positions will suffer. So, investors would be wise to take a more defensive position ahead of an economic contraction.
If you believe that a recession is coming, preservation of capital should be your goal. The days of stocks delivering near double-digit returns might be a thing of the past. With interest rates so low, the opportunity to make 5% to 7% on your money in total — with the benefit of not losing money — might not be such a bad thing.
To achieve a defensive position in this market I would focus on traditional consumer staples, oil stocks and consistent dividend payers. Oil might not seem like an obvious choice, but with crude crossing $100 per barrel on Wednesday, oil companies are cheap relative to the profits rising prices can deliver.
Here are three defensive picks that fit the bill:
When stocks collapsed in the summer, there was such tight correlation that things like defense, growth, value and dividend mattered little. All stocks were lumped into the same cauldron, thanks to Europe’s debt crisis. Stocks were going down together.
Cigarette maker, Altria Group (NYSE:MO) wasn’t immune to the selling. Its shares dropped 12.5%, which simply ignored the fact that Altria would likely increase profits regardless of the economic backdrop. Smokers will smoke no matter what. Altria is a reliable business that should do well in a market focused on recession.
The good news is such correlation is beginning to dissipate. That means fundamentals matter. If a recession hits in 2012, Altria profits will feel it minimally. After all, the company delivers profits like clockwork. Over the last four quarters it has hit the Wall Street number dead on. That’s likely to continue.
For the full year, analysts expect Altria to make a profit of $2.04 per share. In 2012, the forecast is 7% growth, to $2.19 per share. At current prices, shares trade for 13.5 times current-year estimated earnings. Even better for investors is Altria’s 5.9% dividend yield.
You have to love oil in this market. Crude can’t lose. Lack of supply and sufficient demand even in the face of global recession will force prices higher. And if the economy sidesteps a slowdown and demand soars, oil prices will go only higher.
In a defensive posture, it makes sense to own a large integrated oil company like Chevron (NYSE:CVX). These businesses are printing money and paying out huge dividends to investors. Plus, oil company stocks aren’t expensive.
The dislocation in the market this summer also knocked down oil stocks. I view that action as an anomaly and an opportunity to acquire shares at a discount. Even since recovering this summer’s swoon, at $100 per share Chevron is about $10 below its 2011 top.
From an operating perspective, all Chevron does is impress. It has exceeded Wall Street estimates for profits in each of the last four quarters. For the current year, it’s expected to make $13.77 per share. In 2012, profits are forecast to slip to $12.83.
Those estimates for 2012 are heavily weighted to the recession scenario, but they fail to take into account oil prices steadily above $100 per barrel. Even with the slight drop in profits, shares of Chevron trade for just eight times 2012 estimated earnings. There’s no danger of a reduction in the dividend yield, which now stands at just over 3%.
Don’t expect huge returns here, but preservation of capital during in a recession is worth the trade-off.
Fortunately, we’re a long way from a soup-kitchen Depression. While many Americans are struggling, most can still keep food on the table. But low-cost food like soup will surely withstand even a worse-then-expected downturn much better than gourmet fare.
That makes Campbell Soup (NYSE:CPB) a great selection for any defensive portfolio. In fact, as more and more consumers eat on the cheap one could argue that Campbell will increase earnings during a recession. At a minimum, it’s likely to generate cash flow sufficient to pay a very healthy dividend yield, currently at 3.4%.
Campbell has exceeded Wall Street estimates for earnings in each of the last two quarters. For the current year, it’s expected to make $2.37 per share. That number improves by 7% in 2012 to $2.53 per share. At current prices, Campbell Soup trades for 14 times current year estimated earnings.
I would buy Campbell to weather any 2012 recession.
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