The smart-money consensus at this point is that the United States will remain in a slow growth cycle for at least the foreseeable future.
Economists all over Wall Street have been cutting GDP estimates for the rest of 2010 and into 2011. Treasury yields have fallen precipitously over the last several months. 10-year Treasury notes are yielding an anemic 2.63% right now. Making matters worse, is the fact that stocks continue to appear very vulnerable, and taking on significant equity risk in search of higher returns may prove to be a costly mistake.
What should investors be doing in such an environment? The first thing to do is to adjust your expectations. More than likely, you can forget earning 8%-10% annual returns through asset allocation strategies.
Instead of seeking big returns, focus on capital preservation and hope that at some point the investing landscape will get rosier. Bonds appear to be in a bubble phase at this point, although high-grade corporate debt and emerging market sovereign debt may still offer some opportunity.
On the equity side, investors should be looking at the highest quality companies that are engaged in defensive businesses and offer yields in excess of Treasuries. There are some fairly attractive stocks that fit this criteria out there that are trading at reasonable, although not bargain basement, valuations. Among the most attractive are McDonald's (MCD) and Pepsico (PEP).
These two stocks are in a number of sweet spots. First, they are mature businesses which produce tremendous and predictable cash flows, while still being able to offer steady growth - primarily as a result of their exposure to emerging economies.
Second, both companies have very defensive business models. McDonald's sells burgers, fries, and soft drinks and Pepsico sells beverages and snack foods. Both PEP and MCD serve billions of people across the globe and have wonderful competitive moats as a result of their iconic brands and loyal customers.
The third thing that makes these stocks attractive is their reasonable valuation. As noted earlier, neither is exactly cheap, but they are not expensive either. PEP trades at a trailing P/E of around 17, a forward multiple of 14.18 and a PEG ratio of 1.78.
MCD trades at a trailing P/E of 16.69, a forward P/E of 14.98, and a PEG ratio of 1.59. On a valuation basis, they are very similar. A pull-back would be nice, but given the ultra-high quality and ultra-dependable nature of both companies' businesses the stocks are quite attractive at current levels.
The fourth compelling factor that PEP and MCD have going in their favor are dividends. PEP is currently yielding 2.93% and MCD is yielding 3% - both well above the 10-Year Treasury note. In times of turmoil, dividends become important and offer share price support.
Another attractive feature of these stocks for jittery investors is their low beta. MCD has a beta of 0.60 and PEP has a beta of 0.55, indicating they are much less correlated to the S&P than many other securities and will likely outperform in a market decline.
The fifth trait that these stocks have which make them ideally suited for the current environment is their large market caps. In uncertain times, stock investors are more apt to put capital to work in large, established companies. PEP has a market cap of $104 billion and MCD's is $78 billion.
Pepsi and McDonald's are certainly not the only stocks that fit the above attractive metrics. Other names that offer similar profiles are Coca-Cola (KO), Procter & Gamble (PG), and Johnson & Johnson (JNJ) to name a few. Lets take a look at the stats on these securities as well.
Coca-Cola (KO) trades at a trailing P/E of 17.55, a forward P/E of 14.93 and a PEG ratio of 1.90. KO has a market cap of $129 billion and offers a 3.15% dividend yield at current levels.
Proctor & Gamble (PG) trades at a trailing P/E of 17.22, a forward P/E of 14.03, and a PEG ratio of 1.74. PG has a market cap of $172.44 billion and yields 3.17%.
Johnson & Johnson (JNJ) trades at a trailing P/E of 12.26, a forward multiple of 11.80, and a PEG ratio of 1.95. JNJ has a market cap of $163.48 billion and yields 3.64%.
Like McDonald's and Pepsi, these three companies have defensive and predictable business models, tremendous competitive moats and world-class brands, and exposure to fast growing international markets.
Are you going to get rich overnight by investing in any of the aforementioned stocks? Probably not. BUT - and this is important given the current economic uncertainty - you probably won't go broke either.
In the wake of the financial crisis, that is worth something and don't be fooled into thinking otherwise.
Disclosure: No positions