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
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 |
2.46% | 2.58% |
|
Chimera Investments |
4.20% | 4.71% |
|
Invesco Mortgage Capital |
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 |
2.6% | 69% | 9.4 | 12.4 |
|
Coca-Cola |
2.8% | 68% | 12.5 | 15.7 |
|
Microsoft |
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!
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