Over the course of the next several articles we will highlight our Defensive Dividend Portfolio picks for 2012. Each article will focus on a specific low-beta, defensive sector:
- Consumer Staples
- Mortgages REITs
This article focuses specifically on the Utility sector.
The U.S. economy continues to have significant headwinds (e.g., high unemployment, European credit contagion, weak housing market, high debt levels, etc.) and the current "relief rally" is likely to be short-lived.
The global economy is being weighed down by a debt problem that took over two decades to create. Given the significant build-up in peace time debt, we believe that the debt problem will take years to sort out, providing significant uncertainty and market volatility. The leverage that has been built up in the system will not unwind for years to come.
Our central belief is that in a low interest-rate world, retirees and other income investors are experiencing dwindling incomes from their risk-free assets (e.g. government bonds and cash equivalents). With ultra easy monetary policy the Federal Reserve will continue to pick the pockets of savers by keeping rates low. We do not foresee interest rates at the short end of the curve rising any time soon as the debt burdens of sovereign governments as well as consumers are simply too high.
Investors Need to Focus on Stable Income Streams in 2012
As central banks drive down short-term rates to deal with high debt levels and low growth rates, investors have been flocking to dividend stocks in search of yield.
That said, any pullback in the market should be an opportunity to add to your low-beta dividend stock positions.
In the current market environment, it is important for income investors to choose their dividend stocks wisely as they are putting new money to work. As volatility increases (especially downside volatility), income investors should add some low beta stocks to their holdings to help dampen portfolio volatility. In general, companies with low betas will tend to be less volatile than the general market.
With a diversified portfolio of high-quality dividend paying stocks, investors can generate a stable income stream that will perform well in bull or bear markets.
Defensive Dividend Portfolio: Part 1 - Utilities
The Utility sector was the best performing sector in the S&P in 2011, returning almost 15% for investors.
While the long-term trend is still very much in place, the sector has pulled back slightly to start the year. See chart of the Utilities Sector Select SPDR (XLU) below.
Investors should take advantage of this pullback and add some high quality utility stocks to their portfolio. Our favorite stocks in the sector include: American Electric Power (AEP), Consolidated Edison (ED), Duke Energy (DUK), Exelon (EXC), and Southern Company (SO).
While this is not an exhaustive list of high-quality utility stocks, this sample portfolio would yield 4.6% with an average beta of 0.33.