Why You Need Dividends In The Scary Times Ahead: 5 Ideas

by: Bio Insights

Defensive. That's what I would be thinking now, as risky stocks have regained a very large amount of lost ground in the last week and a half. Not only is the Fed's action already priced into equity markets, but money managers are having the jitters again (as they should be!).

Considering that the Dow has gone from just below 11,000 on September 12th all the way to 11,400 as of yesterday and the S&P is above 1200 again, I think it can be safely assumed that the market has priced in at least a large chunk of the relief provided by the European Central Bank for Greece and whatever sort of aid the fed coughs up later today at the announcement (I think many people are expecting an Operation Twist at this point, not a QE3).

Both of these actions are just stalls as we move into autumn earnings season on Wall Street. Considering that it was difficult for the ECB to even prevent a Greek default before the end of this year, 2012 is looking like a very bad year for Europe (and hence the rest of the world). When Greece begins to look for its next round of loans, who is going to want to stack the debt higher? Nobody is left - even China is running out of the cash to help us out.

In another article, I argued that since the only real solution would be to rapidly devalue fiat currencies, one should buy the precious metals to hedge against large spikes in inflation. In addition, an actual default of Greece (and subsequent PIIGS) would send the metal skyrocketing anyway due to outright panic. I believe the risk to reward ratio in precious metals is very favorable despite the bullish speculation.

Now that the possibility of Operation Twist is there, there is another asset class that I think will outperform the market quite handily. If the fed does undergo operation twist, high dividend defensive stocks will be even more attractive next to the paltry yields offered by treasury bills. If the fed does nothing, the market could easily be sent into a panic as the world realizes that central banks are no longer being dovish enough to prop up the markets through currency devaluation. In either scenario, defensive stocks should drastically outperform the risky stocks. I've made a list of defensive strong-dividend companies below that should come out of a global slowdown with nothing more than a scratch.

1.) The Coca-Cola Company (NYSE:KO) - Yield 2.66%

When I first recommended Coca-Cola, it was trading at about $68/share and I predicted that the stock would finally break $70/share in the near future due to its positioning. It finally did soon after the article was published (much to my delight), and its uptrend is still quite intact. The P/E of 13.2 is probably less expensive than you think, given that the company is protected by a bubble of inelastic demand and arguably the strongest brand recognition in the world.

Just a few days ago I compared Coca-Cola to rivals Pepsico (NYSE:PEP) and Dr. Pepper Snapple Group (NYSE:DPS-OLD) in the beverage industry, and determined that Coca-Cola is still going to dominate this specific market for the time being. This was based primarily on growth metrics -- Coca Cola has managed to continue organic growth in every major beverage (even the carbonated favorite Coke) while PEP and DPS lagged behind. It's also a Warren Buffett favorite, if that adds legitimacy to the argument.

2.) Johnson & Johnson (NYSE:JNJ) - Yield 3.55%

I've written about the healthcare giant Johnson & Johnson before, and I still think that the company has relatively small upside potential given a stagnant (and even shrinking) revenue. Despite this, it is a AAA company in an ultra-defensive sector. The company offers a large yield, and in the context of this article it is a stellar way to weather impending bearish macro-events. In my own words, "JNJ is a bond in equity form." I cannot think of a bond with the same degree of safety as JNJ with the ability to pull out at any time. Considering a 2-year Treasury currently offers a ridiculously low .15%, I cannot fathom the rationale behind putting money into those instead of a stock like JNJ.

3.) Pepsico (PEP) - Yield 3.41%

Despite what I've just said about Pepsico lagging behind Coca-Cola in the beverage market, this didn't account for Pepsico's most valuable division -- the snacks and junk food. The fastest growth is coming from Latin America, and demand from North America remains strong. Net income is growing too (albeit slowly) - so investors generally shouldn't fear any dividend cuts. If the United States reaches a state of unemployment and poverty to the point where people can't afford junk food, we've got bigger problems. Pepsico, like Coke dominates its industry and will probably not have any pricing issues in a strong-dollar environment.

4.) Novartis AG (NYSE:NVS) - Yield 4.27%

The companies I've listed so far have been extremely generic, but this comparatively obscure healthcare giant from Switzerland is one of the best investments in healthcare now. I wrote an article centered around its new drug Afinitor, which could end up being one of the best oncology medications in the world given further FDA approvals for treatments. Unlike Pfizer (NYSE:PFE) and Eli Lilly (NYSE:LLY) facing major patent expirations now and in the near future, Novartis is in a strong position until at least 2015 (a lot of time for its current Phase III drugs to get closer to approval).

5.) Duke Energy Corporation (NYSE:DUK) - Yield 5.06%

For the most part, the utility companies have synchronized behavior in the stock market. Recently, utilities have been extremely popular as their yields exceed the treasury yields by huge margins, and the profits are extremely stable. Duke is one of the largest, and offers an enormous 5.06% yield. Despite their strong performance, utility stocks shouldn't have significant downside risk until the risky assets become very attractive again. Given the huge swings of the market and the lack of a long-term solution for Greece and the other PIIGS, this won't be anytime soon.

In conclusion, there is little reason to suggest that the market will move much higher without drastic currency devaluation measures at the FOMC announcement (which are extremely unlikely given the political pressure acting against the fed and Bernanke in particular). There are obviously many more dividend stocks that could have been mentioned, but the five I listed above are examples of what you should be looking for: a non-cyclical nature, dividends, and also a proven track record.

The markets have very recently been rallying due to further delays of Europe's debt problems and hopes that the fed can resolve the situation. Due to this, I think the risk to reward ratio is unfavorable for the indices (NYSEARCA:DIA), (NASDAQ:QQQ), 9SPY) for now, as the fears of an economic slowdown may come back into the picture, causing a quick shift in sentiment. One of the best ways to invest if you want to just escape all this nonsense and ignore the market until the debt issues are resolved is to invest in these defensive and high-dividend stocks. They aren't cheap anymore, but if you are looking for yield stocks are the place to be. If you ever need reassurance, look at Treasury bill rates!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NVS, KO over the next 72 hours.