What To Buy If You Are Afraid Of The Next Bear Market

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Includes: AZO, JNJ, ORLY, YUM
by: Aristofanis Papadatos

Summary

It is a shame to miss the great long-term returns of the stock market due to fears of a bear market.

Investors who have remained on the sidelines during the last 8 years have learnt this lesson the hard way.

In this article, I recommend some securities, which are likely to outperform the market in the case of a bear market.

Bear markets tend to cause permanent traumatic experiences to many investors. This is particularly true for the last bear market, in 2008, which was the worst of the last 80 years. Due to their fear of another bear market, many investors have missed the second longest bull market in history, which has been going on for the last 8 years. As it is a shame to miss the great long-term returns of the stock market due to fears of a bear market, in this article I will advise investors what to buy if they are afraid of the next bear market.

First of all, a bear market can show up at any time. Moreover, no-one can predict when this will occur. During the ongoing bull market, we have heard numerous "experts" call the next crash but the market has kept going up. Therefore, it is a shame to remain on the sidelines for years, waiting for the next bear market. Investors who have adopted this mindset have learnt their lesson the hard way during the last 8 years, as they have been watching one of the most potent bull markets in history.

Apart from those who remain on the sidelines, there are also some investors who are fully invested and have pledged to stay the course regardless of the gyrations of the market. However, most of these investors have overestimated their ability to stay the course, which is much easier said than done. When a portfolio loses 20% of its value in a matter of a few weeks or 40% in a few months, staying the course is extremely hard to achieve, particularly when all the experts declare with full confidence the end of the financial world as we know it.

Therefore, investors should select stocks that have excellent growth record, ample room for future growth, low debt and a reasonable valuation. These stocks are likely to significantly outperform the market during a bear market. This outperformance will not only lead to superior returns, but it will also help the shareholders avoid the disastrous emotional decisions that are abundant in bear markets. For instance, during bear markets, the panic usually reaches a peak near the bottom and hence most investors sell their stocks at the exact worst point. However, if investors hold promising stocks, the latter are likely to exhibit lower volatility and will thus save their shareholders from panic-selling.

AutoZone (NYSE:AZO) and O'Reilly Automotive (NASDAQ:ORLY) are two automotive aftermarket retailers with exceptional records. To be sure, both companies have grown their earnings per share at a double-digit pace for about 40 consecutive quarters. Even better, they hardly show any sign of fatigue. Therefore, even if a recession shows up, the two companies are likely to keep growing at double-digit rates and will thus vastly outperform the market. This is exactly what they did during the last recession. Even better, as they both repurchase their shares aggressively, they will take advantage of the reduced stock prices and will reduce their share count at an increased pace. Consequently, when the economy recovers, they will offer exceptional returns to their shareholders. During recessions, it is much easier to sleep when you know that your stocks keep growing relentlessly and it is just a question of time when the market will price them fairly.

Apart from the above two stocks, dividend aristocrats also tend to exhibit much less volatility than the broad market during recessions. Unfortunately, thanks to the record-low interest rates of the last few years, almost all dividend aristocrats now trade at remarkably rich valuations, with P/E ratios above 20. Therefore, most dividend aristocrats are prone to a strong correction during the next bear market, mostly due to P/E contraction.

Nevertheless, Johnson & Johnson (NYSE:JNJ) is a notable exception. More specifically, this stalwart is trading at a forward P/E=16.1, which is by far the most reasonable valuation in the community of dividend aristocrats. The major reason for this cautious stance of the market is that Johnson & Johnson belongs to the pharmaceutical sector, which is perceived as high-risky due to its fast-changing landscape. However, Johnson & Johnson has such a consistent growth record that it does not deserve to be bundled with the other pharmaceutical companies. All in all, it is an exceptional company, which is expected to grow its EPS by 6% next year and has a reasonable valuation.

It is worth noting that Johnson & Johnson greatly outperformed the market during the last bear market. To be sure, while S&P (NYSEARCA:SPY) plunged 55% from top to bottom, the dividend aristocrat lost just 33%. Thus it saved most of its shareholders from panic-selling and rewarded them with a good night's sleep while other investors were having a traumatic experience.

Finally, there is an even more conservative choice for investors who are afraid of the next bear market. Investors can purchase the 20-year bonds of Yum Brands (NYSE:YUM), which trade slightly below par and offer a 6.875% coupon, thus offering an approximate 7.0% annual yield to maturity. The bondholders of these bonds will easily navigate through the next crisis, as a 7% annual return during rough periods is exceptional.

These bonds double the value of the principal every 10 years, which is great given that they are essentially risk-free. Of course if interest rates skyrocket, the bondholders will incur a great opportunity loss, as they could have earned a higher return elsewhere. However, it is really unlikely that the long-term interest rates will rise much higher than the 7% level. Even better, whenever a recession shows up, the Fed is likely to lower interest rates and hence the above bonds will greatly appreciate in that case. All in all, these bonds are ideal in the case of an upcoming recession.

To sum up, too many investors miss the great long-term returns of the stock and bond market due to their fear of a potential bear market, which however rarely shows up in reality. Instead of waiting on the sidelines, these investors can select the above securities, which are likely to outperform the market during a recession and will thus save their holders from losing their sleep and panic-selling.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long YUM bonds.

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