Think Defensively in a Chutes and Ladders Economy

by Richard Band | November 18, 2011 1:07 pm

It could have been worse — and for a while Thursday, it was. At one point in mid-afternoon, the Dow was off 229 points. However, in the last half-hour of trade, stocks bounced back a bit as investors clung to the hope that somehow the U.S. economy can skirt recession in 2012, even if Europe slides into an abyss. Today, the market continues to waffle — a sight all too familiar given recent volatility. It would seem as if hope and fear are the two major factors driving the market as of late.

Truth be told, that same hope has propped up a bunch of markets recently, not just stocks.

Just look at the oil price. Until Thursday, crude was climbing relentlessly, crossing $100 a barrel Wednesday. It reminds me of May 2008, when oil traders were jubilating over $147 a barrel and salivating at the prospect of $200 (promised in a famous Goldman Sachs forecast).

The economy was already in trouble then. Within four months, the financial crisis exploded to dimensions unprecedented since the Great Depression. By February 2009, West Texas Intermediate was changing hands at $34.

I’m not saying we’re looking at a replay of those events now. However, it seems clear to me that too many U.S. investors are naively ignoring the storm on the other side the Atlantic.

On Thursday, yields on both Italian and Spanish 10-year bonds traded, for a time, above 7%. Although they are now below this major threshold, in a world where the United States and Germany are paying just 2% on similar maturities, a 7% yield is still shocking for one major European sovereign, let alone two. And France might not be far behind!

I continue to believe that the current relief rally for stocks, which began Oct. 4, will carry into December, lifting the S&P 500 Index as high as 1,300 or slightly above.

Given the looming risks, it’s imperative these days to “think defense first” when making your investment moves. That doesn’t mean you have to avoid stocks entirely. But you should confine your new purchases to stocks that offer strong defensive characteristics — such as a generous (and preferably increasing) dividend.

One to consider right now: Baxter International (NYSE:BAX[1]). On Tuesday, the Chicago-based medical supplier raised its dividend 8%[2] — a nice, solid number reflecting strong confidence by management in the company’s 2012 earnings outlook.

Besides throwing off $534 million of cash dividends, BAX has bought back $1.41 billion worth of stock year to date (through Sept. 30). Indeed, I expect dividends and buybacks to take up essentially all of Baxter’s free cash flow in 2011. This is an outfit that believes in sharing the wealth with its owners!

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