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Sin Stocks Trail Their More Virtuous Peers

With the first week of February behind us, one trend has been unmistakable in early 2012: Cyclical and more speculative sectors are outperforming defensive ones.

At 13% year-to-date returns apiece, materials and financials have nearly doubled the 6.9% return of the S&P 500. More staid utilities, telecom and consumer staples are actually in negative territory.

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Although I consider “sin stocks” to be a stock sector in of themselves, tobacco and alcohol generally fall under the umbrella of defensive consumer staples. And as such, the sin stock recommendations of the Sizemore Investment Letter have underperformed the market year-to-date.

After massively outperforming the market in 2011, Sizemore Investment Letter recommendations Altria (NYSE:MO), Philip Morris International (NYSE:PM) and Diageo (NYSE:DEO) have all underperformed the S&P 500 year-to-date.

I continue to recommend the three, and I expect all to generate market-beating returns over time. Sin stocks such as these throw off buckets of cash flow and pay great dividends. They are exactly the kinds of stocks you want to own during a protracted sideways market. At a time when capital gains are unreliable, getting paid in cold, hard cash might be the only return you get at all. And while there is no such thing as a truly “recession-proof” stock, tobacco and alcohol are about as recession resistant as they come.

Bottom line: It makes sense to have sin stocks as a core piece of your long-term portfolio. (For a longer explanation on the virtues of investing in vice, see “The Price of Sin.”)

Investing for the long term is great, but many readers are no doubt asking, “What about now?”

Whether sin stocks enjoy a good 2012 will largely depend on what happens in Europe. If the crisis conditions continue to ease, more speculative sectors should continue to outperform for at least the first two quarters of the year. This is the scenario that the Sizemore Investment Letter considers most likely, and we’ve chosen German, Spanish and emerging-market stocks as our preferred way to profit from this return of risk appetites.

But as investors, we must always hope for the best but prepare for the worst. If Europe slips back into crisis, I expect 2012 to follow the same basic path as 2011: on-again/off-again volatility in a market that hangs on every conflicting word coming out of the mouths of European policymakers. In this scenario, sin stocks would be an attractive safe haven, as they were in 2011.

In the Sizemore Investment Letter, we’re increasing our risk exposure by allocating to riskier sectors. But we’re also hedging our bets by maintaining long-term positions in our core sin stocks. Tobacco and booze served us well during a very turbulent period in the stock market, providing calm and stability when it was needed most. We would expect much the same if the volatility returned.

And if the stocks themselves aren’t sufficient to help us relax, well … we might just have to rely on the products. Scotch, anyone?

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Sign up for a FREE copy of his new special report: “4 Dividend Stocks to Buy and Forget.”

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