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A Port in the Storm: Investments for a Recession

Monday, 03 Oct 2011 12:29 PM

By Tom Hutchinson

Recession is in the air. In fact, it might already be here.

Economic indicators (unemployment, housing prices, industrial production, consumer confidence, etc.) started turning south in the spring.

At the time, many wrote them off as merely reflecting short term headwinds as a result of the Japanese earthquake and the Arab spring.

Better numbers were expected in the second half of the year.

But these bad indicators have persisted through the summer and into the fall. The all important consumer confidence numbers are a particular concern. This indicator typically averages about 102 in good times and 78 during recessions. Today, it is below 50.

Even the Fed, in its diplomatic and non alarmist language, recently sighted "significant downside risks" to the economy.

Given the likelihood that we are either in recession or on the door step of one, where is the best place to put money?

The standard recession investments are safe bonds or cash. As the saying goes "bonds love recession." Normally, the Fed lowers interest rates in an attempt to stimulate or reinvigorate the economy in a recession, and bond prices soar. However, rates are already at historic lows with little room to go lower. As well, the government's inflationary activities (QE and QE2, the stimulus, massive debt levels ect.) could lead to high inflation and rising rates in the not-too-distant future.

In short, bonds offer a microscopic return in an investment that could blow up.

Cash is always safe. The problem with cash is that most investors get back into the market too late, long after it has turned up, and wind up worse off than investors who weathered the market with defensive stocks.

This brings me to defensive stocks. These are stocks of companies in industries that tend to earn stable profits and cash flow in good times and bad; such as Utilities, telecommunications, and healthcare. After all, people tend to take showers, turn on the lights, and get sick regardless of the economy. In addition, because of the stable cash flow, these companies tend to pay high dividends. High dividend stocks tend to hold up better in flat and down markets, and the dividend is there to offset any negative price return.

A stalwart on the defensive stock front is Southern Company (NYSE: SO). Southern Company provides electricity to 4.4 million customers in the southeastern United States through its four subsidiaries in Alabama, Georgia, Florida and Mississippi. The utility is one of the most widely held stocks in the country.

The company continues to operate in friendly regulatory environment with a growing population where it has long term contracts guaranteeing a solid cash flow in the future. Consensus analysts' estimates are for the utility to grow earnings by a solid 6 percent per year over the next five years.

But the best part is the dividend. This company has paid a stable or rising dividend for 243 consecutive quarters. It currently yields 4.5 percent with room to grow in the future. Southern sports a higher dividend yield, lower debt and higher return on equity than the industry averages. As well, the dividend has grown 41 percent over the past decade.

Particularly encouraging about SO is its performance in bad markets. In 2008, when the S&P 500 tanked 37 percent, SO was about even for the year.

The stock has averaged a better than 9 percent average annual return for the past ten years, compared to less than 3 percent for the S&P over the same period.

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