3 Stocks to Avoid and 3 to Buy in a Crazy Market

Fear has more than gripped the markets recently. An air of desperation and panic has engulfed investors as they've watched past gains wiped away in a matter of days. The bad news is that last week, Standard & Poor's decided to downgrade our nation's credit rating, which only served to fuel the already-stoked fire. The S&P 500 is now officially down more than 5% for the year.

The good news is that as the market crashes, it takes down with it fundamentally sound stocks, allowing you to buy them at dirt cheap prices. Read on, and I'll tell you three stocks to avoid and three great dividend stocks that should weather any storm.

What the downgrade actually means
We can't be sure what the U.S. downgrade from AAA to AA+ actually means in the short term. Most likely, markets will remain volatile, and stocks will gyrate more from human psychology than they will from actual earnings reports. For the average Motley Fool investor, you should avoid selling in a panic or altering your normal investing strategy; staying the course is probably your best bet.

Ironically, interest rates have fallen so far, as investors flocked to the safety of Treasuries. However, over the long term, the downgrade might mean that the U.S. will pay higher interest rates on its borrowings. On average, AA-rated countries pay 0.7% more in interest than AAA-rated countries; attach that percentage to trillions of dollars, and all of a sudden we're talking big, big money. This could serve to slow economic growth, stymie any hope of a fall in the unemployment rate, and raise rates on everything from mortgages to student loans.

So which companies could this hurt the most?

Most significantly, this could have a drastically dire impact on mortgage REITs, companies that make a lot of their money from the interest spread between borrowed money and invested assets. These companies typically pay enormous dividends and garner a lot of attention because of the reliable income they provide investors. Some REITs like Annaly Capital (NYSE: NLY  ) , which pays a 14.9% dividend, recently reported a great quarter and a rise in its interest spread, illustrating it's still earning a solid yield on its investable securities.

However, mortgage REITs won't necessarily be so lucky moving forward. Many have portfolios that are made up of mortgages issued by federal agencies like Fannie Mae and Freddie Mac. The U.S. downgrade means that this paper will also be downgraded. So far, fixed income markets have shrugged off the U.S. downgrade, but in the future we could see lower prices for Fannie- and Freddie-guaranteed paper and higher costs for collateral. To put it simply, those dividends you've been relying on for so long may not be as safe as you thought. Here are three companies I'd be wary of before I put my investing dollars on the line:

Company

Q2 Interest Spread

Q1 Interest Spread

American Capital Agency (Nasdaq: AGNC  ) 2.46% 2.58%
Chimera Investments (NYSE: CIM  ) 4.20% 4.71%
Invesco Mortgage Capital (NYSE: IVR  ) 2.75% 3.12%

Source: Capital IQ, a division of Standard & Poor's.

Interest spreads have gotten worse as most companies saw a disproportionate rise in their cost of funds in contrast to their average portfolio yield.

High dividends are great, but when they start to plummet because of interest rates -- don't say you weren't warned.

3 stocks worth your investing dollars
Despite the fears of a slowing economy, most investors still prefer to invest in U.S. stocks over their foreign counterparts, something referred to as "home bias." People have a preference for things they understand and can relate to, so most of the time, U.S. investors stick with domestic stocks regardless of the situation.

If you're one of those people, now you might be asking yourself if the stock market is too risky because of an uncertain economy and political fragility. The short answer is that, yes, it's risky in the short term. The more adequate answer is that, no, it's not that risky in the long term -- that is, if you're investing in the right companies.

Remember that we're living in a global economy, one where companies trade and deliver goods and services across the world. U.S. companies may be based at home, but some of them do a significant amount of business abroad. And even though the economy might be faltering, the U.S. still has some of the most reliable, recognizable, and profitable brands in the world.

Below I've chose three companies based on (a) value, (b) brand power, and (c) revenue diversification.  Each company pays a solid dividend, is trading well below its five-year average, and earns at least 40% of their revenues outside of the United States.

Company

Dividend Yield

Revenue Outside the U.S.

Current P/E Ratio

5-Year Average P/E Ratio

ExxonMobil (NYSE: XOM  ) 2.6% 69% 9.4 12.4
Coca-Cola (NYSE: KO  ) 2.8% 68% 12.5 15.7
Microsoft (Nasdaq: MSFT  ) 2.5% 46% 9.4 11.2

Source: Capital IQ, a division of Standard & Poor's.

Don't wait to pick these up
According to brand marketing company SyncForce, Microsoft has the fourth most powerful brand in the world, followed by Coca-Cola in seventh place, and ExxonMobil in 30th. These companies have economic moats wider than you can imagine based on their longevity and their ability to outshine their competition. Furthermore, they've proven to be reliable and profitable; each of these companies has outperformed the general market for the last 20 years -- no easy feat at all.

The stock market might be heading downward, but fortunately for investors, we're able to pick up some amazing companies at rock-bottom prices. As you can see from the chart above, these three stocks are trading well below their five-year averages and are geographically diversified enough as to avoid getting caught in the isolated web of the U.S. economy. My suggestion: Grab 'em while they're cheap!

Still concerned about the market's unavoidable downfall? Click here to check out this brand new, free video, "Watch This Before the Market Crashes." During the video Motley Fool experts give you one amazing company to buy that "could be the next Intel." Watch the video now!

Jordan DiPietro owns no shares. The Motley Fool owns shares of Coca-Cola, Chimera Investment, Annaly Capital Management, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft and Coca-Cola. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (25) | Recommend This Article (70)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 12, 2011, at 3:35 PM, revealedin71 wrote:

    I will take the other side of this trade. The 3 stocks noted to avoid have had to endure the siren song of the skeptics for the past several years. In fact, the Fed's statement on Tuesday for up to more years of essentially 0% rates bodes well for AGNC and the others,even if there is a downgrade in agency paper. Plus these firms have demonstrated very capable, intelligent management that has manuevers well in these markets.

  • Report this Comment On August 12, 2011, at 3:36 PM, revealedin71 wrote:

    corrections... ...up to 2 more years ...

    ..have demonsrated...

    sorry...revealedin71.....

  • Report this Comment On August 12, 2011, at 4:18 PM, Bulrun100 wrote:

    LOL!! What I find funny is the three stocks mention haven't done much in years BUT stick with those????? Move away from Mreits borrowing at 0% and printing money for 2-3 years!Huh!!!!!!!!!!!!!!!!!!!!!!!

  • Report this Comment On August 12, 2011, at 4:25 PM, wigan4 wrote:

    I'll take the other side of that trade too. There's only one reason a stock like AGNC yielding 20% is still yielding 20%--uncertainty. Bernanke just eliminated most of the uncertainty.

    So what if the worst case happens and the spread becomes 'only' 1.5%? 1.5 x 7.5 is still over 11%. I'll take that in heartbeat.

    And frankly, now that that bottom number is essentially pegged for two years I'm ok if they want to leverage even a little more.

    I think mortgage REITs verge on risk-free free money for the next 18 months. And since the annoucement the market has been agreeing.

  • Report this Comment On August 12, 2011, at 4:36 PM, howbertr wrote:

    And if "eventually" the US had to pay more more because of that "corageous" downgrade which the bond market is obviusly not taking seriously, how bad would it be if those dividends were even cut 50%???????

  • Report this Comment On August 12, 2011, at 5:06 PM, TMFPhillyDot wrote:

    It's not that I don't think the announcement of lower rates for essentially the next 2 years is a good thing for these companies, but there is still an inherent danger in owning them "just for the dividend" when their dividend is so sensitive. And don't necessarily count on capital appreciation -- CIM is down 20% over the last 3 months, IVR is down 19%, and this is while the S&P is only down 12%.

    So, take it for what it's worth -- but I'd much rather take advantage of the psychological panic in the market and grab great names like MSFT and KO. In fact I just grabbed CSCO a few days ago and it's up over 15%.

    Regardless, thanks for your comments and good luck!

    Foolishly,

    Jordan (TMFPhillyDot)

  • Report this Comment On August 12, 2011, at 5:29 PM, gashog42 wrote:

    Way to go GOP!!!!

    By refusing to compromise on the debt ceiling issue -- like a little kid who took his bat and went home -- you directly contributed to the rising deficit!

    With idiots like you in control of the House it's no wonder the country's investors are in a panic!

  • Report this Comment On August 12, 2011, at 5:59 PM, TipTopTommyT wrote:

    gashog....actually, the GOP did compromise (unfortuntately) with Reid in the Senate...that was the problem. The president showed no leadership on this issue as he had NO plan! He was AWOL on one of the most crucial issues in recent memory. So we got a bill that had no ceremony because it did little to ease the financial crisis.

    There were some in the GOP who put forward real spending cuts in the cut, cap, and balance bill that both Reid and Obama outright rejected.

    So they rejected a bill that would have avoided a credit rating downgrade and make an indelible impact on strengthening our fiscal condition.

    The "idiots" are not in the House...start at the top to find one.

  • Report this Comment On August 12, 2011, at 6:11 PM, windycityart wrote:

    Yet another writer/pundit recommending Microsoft. The only problem with that recommendation is that the market hates Microsoft stock. It just never goes up. Never. No matter how good the news, how good the financials, it never goes up. Doesn't go down much either. January 1, 2002 Micrososft closed at 31.42. Today $25.10

  • Report this Comment On August 12, 2011, at 6:21 PM, Chontichajim wrote:

    Of the three only KO has outperformed the market the last two years so I am holding it. MSFT? How are they going to grow the PC market which will drop even in good times while their software is not as good as competitors. XOM? What planet are they going to find new oil reserves on? All of the reserves on this planet have been found and XOM has not diversified enough (I hold BP and TOT). NLY is a hold for me, and it did not drop with the recent market. I bought CIM today after watching it 6 months hoping it has dropped enough to make it worth it.

  • Report this Comment On August 12, 2011, at 6:28 PM, Storyteller28 wrote:

    OK I'm confused. I know a great deal has happened since 8/5/11 but Ilan Moscovitz wrote a piece called

    "10 Outstanding Dividend Stocks to Buy in This Crazy Market." Two of those were CIM and NLY.

    He said, "When unemployment is high and inflation is low, as is the case today, the Federal Reserve keeps short-term interest rates low. The increase in the spread between short- and long-term interest rates is a boon to mortgage REITs."

    Given the Fed's recent actions those elements seem to be in place for at least the next 2 years. Through the madness of the last 5 days NLY's price has remained remarkably stable.

    I'm confused. A seeking Alpha article makes the contrarian view. It is here:

    http://seekingalpha.com/article/286967-7-mortgage-reits-yiel...

    Please help me think this through.

    Thanks.

  • Report this Comment On August 12, 2011, at 6:45 PM, Emperor2 wrote:

    Get your facts straight. if the Dem's hadn't added 2 trillion dollars to our debt in the past 2 years then we wouldn't have this crisis. And the Dems just want to print more money, not reduce any spending. If all we do to pay our bills is print more money we will be like some of the European countries in the 1940s when it took a wheelbarrow full of paper money to buy a loaf of bread.

    The country's investors are in a panic because of the shameful way the Democratic Party has ruled this country for the past 2 years. They controlled both houses of Congress and the White House yet the Senate couldn't even propose a budget in that entire time. In fact, it's been almost 3 years since they have proposed a budget.

    The investor community is in a panic because our COMMUNITY ORGANIZER isn't a leader. Instead of leading, he let's Congress dictate to him. Jimmy Carter is smiling cause he's no longer the worst President this country ever had.

    The investor community is in a panic because the Republicans don't seem to have any better way to solve our debt crisis than the Dems. The Republicans aren't any more willing than the Dems to take the necessary steps to solve our debt problems.

    Both parties, and the COMMUNITY ORGANIZER, put getting re-elected before doing what is best for our country. If you are a Dem, you blame the Reps. If a Rep, you blame the Dems. But if you take you head out of the sand you will realize that BOTH parties are at fault. Even worse, we don't have a leader in our country that will work with both parties to achieve what is best for our country.

    I worry for my grandkids. What sort of country will they inherit? I wish I could move to a warm tropical Caribbean island and say the heck with the U.S. problems. The problem is i love this country too much. I'm a retired military and survived getting hit by hand grenades. But now I'm scared for our country.

    Dems are stupid. Repubs are idiots. The COMMUNITY ORGANIZER is useless. I don't know what will happen in the future but it scares the heck out of me.

  • Report this Comment On August 12, 2011, at 6:47 PM, RandomActs43 wrote:

    Jordan -

    Curious about two things...

    1) Why did you write about NLY, but then ignore it as either an avoid or buy?

    2) Why XOM? Royal Dutch pays a higher dividend and is better rated by analysts?

  • Report this Comment On August 12, 2011, at 6:58 PM, goscuderi wrote:

    Most mREITs at current prices are paying dividends at a rate of 14% to 20% -- and look to be able to continue doing so. The dividends will drift down over time -- no doubt about it. Suppose that you are right and they can only pay dividends at a rate of 10%......in a 0% interest rate environment. Then what? Are investors going to "flee" the REITs because they "only" pay a 10% coupon?

    REITs are vulnerable to a rise in interest rates, and, especially, to a flattening in the yield curve (a bear market and a flattening yield curve -- that is to say, a sharp rise in short term interest rates -- would be a problem).

    Do you see a sharp rise in short term interest rates in the cards here, in the short to intermediate term? Isn't the news of the day whether the Fed will act as soon as today to implement QE3?

    Your on the wrong side of this trade, especially with NLY, which is levered only 6 to 1.

  • Report this Comment On August 12, 2011, at 7:25 PM, TMFDiogenes wrote:

    "OK I'm confused. I know a great deal has happened since 8/5/11 but Ilan Moscovitz wrote a piece called

    "10 Outstanding Dividend Stocks to Buy in This Crazy Market." Two of those were CIM and NLY."

    Good question. In keeping with the "motley" aspect of Motley Fool, Jordan and I disagree about the outlook for mortgage REITs. He's right to suggest that a downgrade of Fannie and Freddie-backed securities could result in higher borrowing costs for the REITs (my article went was published before the downgrade.) But so far, I still think well-managed ones will be okay so long as the Fed funds rate remains where it is (probably at least 1-2 years) and we don't have another big financial crisis.

    Ilan

  • Report this Comment On August 12, 2011, at 7:33 PM, techy46 wrote:

    I've already taken both sides of this trade and intend on strengthening both; LONG GE F FLEX HCBK INTC MSFT NLY T living off 5.5% dividends

  • Report this Comment On August 12, 2011, at 11:55 PM, teeba11 wrote:

    What effect, if any, does the recent sale of 120million new shares have on NLY's dividend per share? I am new to these REITs

  • Report this Comment On August 13, 2011, at 12:06 AM, teeba11 wrote:

    Disregard that last post. Not thinking clearly. Sorry

  • Report this Comment On August 13, 2011, at 12:36 AM, Midas5280 wrote:

    Microsoft is like GE: goes up a little, then down a little, but doesn't do a whole lot. No thanks.

  • Report this Comment On August 13, 2011, at 2:12 PM, Storyteller28 wrote:

    I spent the night doing research -- trying to build an argument against mortgage REITs in this current interest environment. The following REITs seem quite stable and well managed with extremely attractive high yield returns.

    American Capital Agency Corp. (AGNC)

    Current Yield: 19.7%

    Annaly Capital Management, Inc (NLY)

    Current Yield: 14.5%

    Hatteras Financial Corp (HTS)

    Current Yield: 13.9%

    Chimera Investment Corporation (CIM)

    Current Yield: 16.7%

    Cypress Sharpridge Investments (CYS)

    Current Yield: 19.1%

    Invesco Mortgage Capital, Inc. (IVR)

    Current Yield: 18.5%

    MFA Financial (MFA)

    Current Yield: 12.8%

    As has been pointed out above even were their dividends to slip by 30% the return is still very attractive. Their risk has always been increasing interest rates but the Fed has taken that risk away for the next 1-2 years.

    What am I missing? They seem to be a very attractive compliment to a well balanced portfolio.

  • Report this Comment On August 14, 2011, at 4:25 PM, mikecart1 wrote:

    Best bet is to invest in NLY and/or CIM if you want REIT exposure with solid history. Their dividends aren't going away anytime soon. At worst they will drop from 15% or so to around 10%. Still better than 95% of other dividend stocks. With the economy still in the toilet, these 2 stocks are solid. Just don't put everything you have in them. Just enough to get a solid payment every 3 months and laugh at the haters!

  • Report this Comment On August 16, 2011, at 1:39 PM, philisafool wrote:

    One note fellow fools...CIM is externally managed by Fixed Income Discount Advisory Company (FIDAC), a wholly-owned subsidiary of...wait for it...Annaly Capital Management, Inc.

  • Report this Comment On August 19, 2011, at 2:39 AM, prtoricn wrote:

    My daughter just started university as a junior. I would like to start investing in the stock market, to get her started. what stocks should i buy that are affordable that will make a profit in time? (for more than 10yrs.) she will take over and deduct a % of her income from her job into her investments. I read this article & comments. can anybody give me some advise? I would like to start now, the market is cheap and low & a great time to buy. oh! does anybody think fidelity investment is a good broker to start with compare to others?

  • Report this Comment On August 19, 2011, at 6:21 PM, 1022ThirdAvenue wrote:

    prtoricn:

    If you want to waste a significant portion of both your dividends and principal on stock brokers, Fidelity is just as good as any of the others. Heck, if you want to give U.S. Bank a good portion of both each year, they will gladly take your money with a floor of $5,000 per year independent of the amount of funds you have on account. If you are lucky enough to have more than their "minimum", you will be charged 1.5% of the total value of your portfolio per year. For all that they charge you, you can be certain of a substantial annual decline in the value of your portfolio. With any luck, you will be flat bust in 20 years with any broker you might choose to use.

    However, since you are on Motley Fool, you will probably be selecting stocks that are within your own risk tolerance and that will provide you with a total return that is acceptable to you. I would, therefore, suggest that you use ETrade, or one of the other on-line brokers. From personal experience, I know that ETrade charges a flat transaction fee of $9.99 per trade. ETrade has a tremendous portfolio of tools to assist the investor, and they even have offices around the country staffed by competent individuals, at least the one in Minneapolis is competent.

    Good luck.

  • Report this Comment On August 20, 2011, at 5:04 AM, donalddmorgan wrote:

    Dear prtoricn:

    I agree with 1022third avenue's advise to use Etrade. Their service is excellent and quite inexpensive.

    You did not specify how much you have to invest, but it sounds like you are looking for good dividend stocks to produce income and provide a degree of safe appreciation.

    Stocks with solid longer term records of consistent earnings and periodic increases in their dividends would sound like a good investment strategy for your daughter's investments.

    Here are some stocks to review. I have noted their stock symbols and current dividend yields;

    Total (TOT) 5.1%, GalxoSmithKline (GSK) 5.4%, Southern Copper (SCCO) 7.1%, Annaly (NLY) 14.1%,CenturyLink (CTL) 8.4%, Altria (MO) 6.1%

    Natural Resource Partners (NRP) 7.4% and National Grid (NGG) 6.2% All these companies have solid histories of increasing dividends and solid earnings to support the dividends. If you know how to write covered call options against the stocks you own you may be able to add another 3-4% to the stock yields if you collect the option premiums like additional dividends, while maintaining a healthy spread between the market and the price you agree to sell your stock in the option contract you sell (the "strike" price).

    Hope this helps

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