The housing downturn, credit crunch, gloomy employment data and a parade of maudlin financial forecasts have been enough to send some investors scrambling for bubble gum and beer.
While economists jawbone about whether the United States will sink into recession, investors already are thinking of ways to prepare their stock portfolios for a downturn.
Even if there isn't a full-blown recession — usually defined as two consecutive quarters of negative economic growth — many investors and strategists are bracing for a significant slowdown in growth.
It's going to feel a lot like recession," said David Kostin, global investment strategist at Goldman Sachs, which is forecasting 1 percent gross domestic product growth, but not a recession, in the first quarter of 2008. "That's pretty anemic growth, and I believe the market is likely to trade like it's going into a real recession."
Investor jitters led Kostin to compile a list of 35 companies in 10 sectors that have held up well in previous cyclical downturns. The median returned 15.6 percent during previous recessions compared with 6.2 percent for the Standard & Poor's 500-stock index. Among his picks: Walgreen Co. (NYSE: WAG), Microsoft Corp. (Nasdaq: MSFT) and Lockheed Martin Corp. (NYSE: LMT).
Indeed, investors are starting to stock up on the usual slump-resistant suspects that make his list: consumer-staples makers, health-care companies and utilities.
They also are increasing their holdings of large corporations with exposure to international markets because global economic growth continues to outpace the United States.
"People still need to eat, get drugs at the drugstore and go to the supermarket," said Bob Barringer, co-manager of the Pegasus Fund at FBR Funds, which has about $2.3 billion under management. "You're looking for stable, steady-growth companies with an attractive free cash-flow yield and good margins," he added.
Free cash-flow yield is a measure of a company's cash-generation power — and the higher, the better.
Barringer favors Campbell Soup Co. (NYSE: CPB), which, at the end of July, reported a gross profit margin of 42 percent and a 19 percent margin of earnings before interest, taxes, depreciation and amortization, or Ebitda, according to data from Capital IQ.
It has a respectable 6.8 percent free-cash-flow yield and is trading at about 17 times per-share earnings for the fiscal year that began July 30, according to Thomson Financial.
He also likes Wm. Wrigley Jr. Co. (NYSE: WWY), the 116-year-old confectioner that has the leading U.S. share in chewing gum. In hard times, when consumers might cut back on their pricey morning coffee, a stick of gum can be "a simple pleasure," Barringer said. Wrigley's Ebidta margin has been holding steady at about 23 percent, while its free-cash-flow yield is a fair 4.9 percent. The shares are expensive, however, trading at about 27.7 times this year's per-share earnings.
In a similar vein, British liquor distributor Diageo PLC (NYSE: DEO) should be a safe bet because consumers tend to keep drinking during economic downturns, said Randall Haase, who manages the Baron Fifth Avenue Growth Fund and oversees about $250 million in assets.
The American depositary receipts of Diageo — whose brands include Smirnoff vodka, Captain Morgan rum, Johnnie Walker whiskey and Guinness beer — are trading at about 18 times 2008 estimated earnings, slightly richer than its peers.
In health care, biotechnology company Genentech Inc. (NYSE: DNA) is a recent pick for Jim Huguet, who helps to manage about $400 million at Great Companies Inc., an investment firm in Tampa, Fla. He looks for companies with at least 20 percent annual earnings growth for at least five years, and Genentech fits the bill, he said.
It's a bargain compared with the broader biotech sector, which, according to Thomson, is trading at nearly 62 times expected 2007 earnings. Genentech trades at 27 times expected 2007 earnings.
In previous cycles, financial stocks with mortgages on their books qualified as recession-proof because investors expected people to pay their mortgages even if they scrapped everything else. These days, with the subprime and housing meltdowns, investors are pickier.
One way to play is to buy the biggest, most diverse financials that have leading market share, expanding foreign-income streams — a good recession bet because economists expect international growth to outstrip U.S. growth — and return on equity that surpasses the U.S. average of 14 percent, said Ron Muhlenkamp, who runs the $2 billion Muhlenkamp Fund in Wexford, Pa.
He likes Citigroup Inc. (NYSE: C) and insurer American International Group Inc. (NYSE: AIG). "These are nicely profitable companies that should have some growth and are selling quite cheaply," he said.
Citigroup, the nation's biggest bank with a market value of $234 billion, has a return on equity of about 18 percent. Almost half of Citigroup's net income in the second quarter came from international operations, a proportion the company is trying to increase. However, its shares appear cheap, trading under 10.5 times this year's earnings estimates, partly because its U.S. consumer business hasn't been growing significantly while its expenses have been rising.
AIG, which has a market value of $172 billion, has a return on equity of 17 percent, according to Capital IQ. Its foreign life-insurance, general insurance and retirement-services businesses contributed 35.5 percent of net income before taxes and minority interest.
Its shares are trading at 10 times estimated earnings for 2007. Like many other financial stocks, AIG has been hurt by investors' concerns about the firm's subprime-mortgage exposure.