5 Stocks for a Rotten Environment

At the beginning of this month, I highlighted Marc Faber's warning that all industrial commodities are vulnerable to a slowdown in China's property market. That process now looks to be well underway: Industrial commodities suffered across the board in May as investors focused on the Chinese government's efforts to prevent their economy from overheating (not to mention Europe, which will almost certainly act as a drag on global growth over the next several years). Oil and copper were off their highs by more than 20% this month. 

Not to worry: Stock investors can still hedge some of the macro risks in the current "minefield" environment, and they could earn solid returns in the process.

The inflation/deflation see-saw
Deflation is the biggest near-term risk in the U.S. and other developed economies. But in the long run, inflation (or hyperinflation) could pose a greater danger, as governments fight the temptation to pay back the huge sums they've borrowed by printing more money.

That dichotomy presents a genuine conundrum for investors who wish to hedge their inflation risk via commodities, but are wary of doing so in the face of falling commodity prices and raised uncertainty about the strength of the economic recovery. The United States Oil Fund (NYSE: USO  ) , which tracks the price of crude oil, has lost 21.9% so far this month, for example.

A major improvement over commodities
One solution that looks attractive involves gaining exposure to commodities through the shares of resource companies. In particular, several European oil majors are trading at historically low multiples and offer substantial dividend returns:

Company

Forward P/E Multiple*

Dividend Yield

Total (NYSE: TOT  )

6.0

6.5%

Repsol (NYSE: REP  )

6.5

4.7%

BP (NYSE: BP  )

5.5

7.7%

Source: Capital IQ, a division of Standard & Poor's, Yahoo! Finance.
*Intraday May 24, 2010, based on calendar year 2011 estimated earnings-per-share.

Commodity exposure with a margin of safety
BP, of course, has been tarred by the oil slick in the Gulf of Mexico, and all three companies have been caught in the downdraft resulting from the European debt crisis (especially Repsol, which is based in Spain). Still, the companies' long-term earnings power doesn't seem impaired, and current valuations appear to offer a margin of safety regarding that risk. To those three names, I would add Royal Dutch Shell (NYSE: RDS-A  ) (NYSE: RDS-B  ) and ConocoPhillips (NYSE: COP  ) . Together, these five stocks could provide major relief to investors caught between a rock and a hard place.

China isn't the only economy experiencing booming demand for commodities and infrastructure: Tim Hanson describes the biggest investment opportunity this year.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Total SA is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On May 24, 2010, at 12:22 PM, PeyDaFool wrote:

    Is it reasonably safe to assume BP will keep up the 7.7% dividend or do you believe that will drop due to the gulf disaster?

  • Report this Comment On May 24, 2010, at 2:55 PM, stan8331 wrote:

    Trying to hedge risk by going into European oil companies seems like an odd strategy to me. It COULD work out well, but there are plenty of other energy companies that have also been beaten down recently but aren't so directly exposed to European risks. And with BP in particular, it is a massive company but I think it's dangerous to assume we know the full extent of the hit that it will end up taking over the ongoing Gulf disaster.

  • Report this Comment On May 24, 2010, at 4:46 PM, TMFAleph1 wrote:

    stan8331,

    "And with BP in particular, it is a massive company but I think it's dangerous to assume we know the full extent of the hit that it will end up taking over the ongoing Gulf disaster."

    Thanks for your comment and I salute your skepticism and prudence. However, my inclination is to believe that the market, which abhors uncertainty, tends to overestimate, rather than underestimate the cost in these situations -- especially in the immediate aftermath of a crisis.

    This reminds me of Bhopal disaster of December 1984. Within a month of the tragedy, Union Carbide had lost approximately a quarter of their value (this is similar to the current decline in BP shares). From that point on, Union Carbide shares gained 93% over the following 12 months (Dec. 31 1984 to Dec. 31, 1985), compared with a 26% gain in the S&P 500.

    This is but one example, to be sure, but I think investor overreaction is a common response to a crisis.

    Best,

    Alex Dumortier

  • Report this Comment On May 24, 2010, at 6:14 PM, TMFAleph1 wrote:

    By the way, the final death toll of the Bhopal disaster was estimated at between 15,000 and 20,000 -- a tragedy of fantastic proportions.

    http://www.britannica.com/EBchecked/topic/1257131/Bhopal-dis...

    Alex Dumortier

  • Report this Comment On May 24, 2010, at 6:19 PM, MegaEurope wrote:

    Hmm... Some sources give Repsol 2011 earning estimates way lower than you suggest. For example, the CAPS page.

    I would avoid them in favor of of Total, BP, Shell, Eni, Statoil, etc. because Repsol has a higher debt load.

  • Report this Comment On May 25, 2010, at 1:01 AM, timbrown11 wrote:

    I like this article and would choose to own one of these three. Other than the selloff today, it appears that TOT and BP have both moved downward at approximately the same pace. My hypothesis is that potentially the European weakness is weighing on BP as much as the oil spill. Hence, would it make most sense to own TOT versus BP? It seems that one would be getting the dividend and the upside without the uncertainty and risk associated with the prolonged liability of BP?

  • Report this Comment On May 25, 2010, at 9:01 AM, TMFAleph1 wrote:

    Here is an interesting attempt to compare the potential cost to BP of the Gulf of Mexico spill to the loss in stock market value:

    $47bn and counting, ft.com Alphaville, May 25, 2010

    http://ftalphaville.ft.com/blog/2010/05/25/241936/47bn-and-c...

    Alex Dumortier

  • Report this Comment On May 25, 2010, at 9:08 AM, ttboydxb wrote:

    I'm a big fan of Total and Statoil. My 0.02

  • Report this Comment On May 25, 2010, at 2:35 PM, TMFAleph1 wrote:

    @stan8331,

    Here is another interesting article which analyzes the potential impact on BP shares of this disaster:

    BP Risks Being Tarred by Safety Discount, WSJ Heard on the Street, May 25, 2010, Page C20

    http://online.wsj.com/article/SB1000142405274870411350457526...

    Best,

    Alex Dumortier

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