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Archive for Monday, October 29, 2001

Six steps for recession survival

Defensive investors can look for leaders in basics, health

October 29, 2001

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Let's stop beating about the bush: The recession is here, well and truly. It only awaits a few more numbers for the confirmation.

So just how should an investor prepare? Accept lousy CD rates? Take a flier on more aggressive stocks? Sell the mutual funds? Bury the money outdoors?

To help you sort it out, here's an investor's survival guide to the recession. Remember, a recession is not a monolithic event. It does not inflict suffering on everyone or rather, it inflicts it on some more than others.

Here are six rules to remember as a defensive investor:

Don't rush to buy. The recent tech rally may have convinced you that the rebound is here, and that you need to jump in now and buy. With some exceptions, you can resist the temptation. Although there's been modest improvement in the fundamentals of some companies, what's going on here is primarily a trader's rally. That's to say that the overall economic outlook remains grim, and several strategists believe the market likely will test its lows again before it moves upward.

The American Economics Group, an analysis firm in Washington, D.C., says recovery is three to four quarters away. If you assume the market anticipates recovery by six months, that suggests the time to buy is at least three to six months away. Of course, no one knows for sure.

But don't obsess about missing the train.

Look for the leaders. In a recession, investors tend to look for the basics. And there's nothing more basic than whether a company will survive. This may not be fair, but it means that many investors will prefer the leading company in any niche a Cisco, say, instead of a Nortel; Intel over AMD; or Microsoft over RealNetworks.

"This quarter, investment sentiment has changed from 'How bad can it get?' to 'We know it's bad, who can survive?'" Banc of America Securities analyst Chris Crespi said, writing in his recent note to investors.

B of A Securities has added a new dimension to its company analysis, called "quarters of operating cash," basically a measure of how long their money will take them: Cisco has 9.3 quarters of operating cash, a healthy amount. Nortel, however, has about one month.

In retail, go for generic over brand, and local over distant. As an investor, it helps to put yourself in the shoes of a shopper, both literally and figuratively. As budgets are squeezed, people increasingly will shop at discount outlets rather than at higher-priced department stores or specialty shops. Thus, Wal-Mart is probably a better bet than Federated Department Stores, which owns Macy's and Bloomingdale's.

A corollary: People will seek cheaper and, given recent events, safer forms of entertainment and travel. If you own a real estate investment trust that invests heavily in hotels, be prepared for trouble. But a sleeper probably is Blockbuster, a publicly traded Viacom subsidiary that expects to perform decently as people rent movies to watch at home.

Some defense and security stocks will be winners. Given the U.S. response to the terrorism of Sept. 11, this hardly is a surprise. One of the big changes in the coming years will be the federal government's spending on defense. The American Economics Group, for instance, estimates that defense spending will increase by nearly 40 percent by the year 2005.

Look for companies that supply the military with hardware (Lockheed Martin) or cruise missiles (Raytheon) to continue to do well. And tech companies that can boast that security is a piece of their portfolio, like CheckPoint or Verisign, will have a better chance than those that don't.

Health usually is evergreen. The standard recession stocks are the pharmaceuticals: Merck, Eli Lilly, Abbott Laboratories. And they'll probably do better than many others, even though they face competition from generic rivals.

Al Kildani, an analyst with Pacific Growth Equities, poses a more sophisticated question in judging whether to invest in a health-related or medical-device stock: Will the cost be reimbursed by insurance?

Kildani's point is that reimbursed services will continue to thrive. Procedures that are not covered or poorly covered will face problems. That means knee surgeries likely will continue to go forward. But laser eye corrections probably will suffer.

Some of the stocks Kildani likes: Cytyc, a maker of a new diagnostic pap test, which he concedes is richly valued at 39 times forward earnings but is growing rapidly; and Arthrocare, which offers minimally invasive methods for surgery.

Dividends matter. Yes, Martha, these quaint payments from companies, which tech companies generally forgo, do matter in a recession. The point is that you generally can count on a higher return from the dividend alone than you can get from a bank CD.

Among the leaders, for better or worse, are the tobacco companies. Philip Morris, which pays a yearly dividend of $2.32 per share, has a yield of 4.61 percent. And UST Inc., the holding company for smokeless United States Tobacco, has a yield of 5.33 percent. Some of the utility and oil companies also pay handsome dividends.

Even the hedge funds have discovered dividends. One Maryland-based hedge fund manager, Tobin Smith, who runs the ChangeWave funds, says he regularly invests in a gas royalty trust, Enerplus Resources Fund, which pays a healthy dividend with a yield of more than 18 percent.

Remember the vices. In a recession, people tend to worry. This means generally good times for the purveyors of junk food, tobacco and liquor. Tobacco stocks like RJR Reynolds or Philip Morris, for example, have done very well in just the past two months, climbing by 18 percent and 17 percent respectively. They're slightly below their 52-week high.

One example close to home makes my point: One of our business editors offers a stash of M&M's and carrots at his desk every day. One day recently, hungry reporters went through a week's worth of M&M's in a single 24-hour period. M&M's are made by Mars, which, alas, is a private company. But as a proxy, you could take Hershey, which has been in a holding pattern at about $60 per share. After all, investors prefer sweet to sour.

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