"Prepare for a Global Economic Downturn" and "U.S. Recession: Already Here" are just a few of the foreboding predictions gracing early-2008 headlines.
Investors are panicked, and for good reason: Effects of the recent subprime meltdown are still playing out, more than five months after the first word of company writedowns.
Needless to say, one big question remains -- will the weakening economy survive, or will it go into serious recession? (And what does this mean for investors!?)
So far, no good
Though the Federal Reserve is not currently forecasting a recession, early 2008 data speaks for itself:
- The housing market is going through its worst slump in recorded history.
- Consumer confidence is approaching a two-year low.
- At 5%, the unemployment rate has reached a two-year high.
So what does this mean for investors? Are bonds and Treasuries the only safe investment choices during a downturn? Not quite, but ...
Choose your investments wisely
Certain sectors (and stocks) are proven performers during an economic recession, and they can actually provide a special investment opportunity.
According to Wharton professor Jeremy Siegel, reinvesting dividends can generate wealth for long-term stockholders, particularly during recessions. The dividend yield (dividend per share divided by price) helps to demonstrate this concept.
If a stock trades for $100, and it pays $3 in yearly dividends, it has a yield of 3%. When stock prices fall, the yield subsequently increases. At times like those, reinvested dividends allow you to purchase more shares at lower prices. If all goes according to plan, the extra shares then rise in value when the market recovers, launching total returns higher.
The power of dividends
In addition, growing dividends are often considered a sign of improving finances through all market cycles, since the companies paying them need to generate enough cash flow to return larger checks to shareholders. At the end of the day, the compounding effect of these growing dividends, reinvested methodically, will engineer big returns.
Consider PepsiCo
I'll drink to that ...
Like PepsiCo, many reliable, dividend-paying giants are recession-resilient consumer staples -- companies that provide products people consistently buy, even when times are tough.
For example, according to a Standard & Poor's study reported in Time, the S&P 500 has lost an average of 21% during past recessions. But the average consumer-staples stock lost a mere 2.4%. In some cases -- beverage makers, household products, and tobacco -- this sector has even beaten the market during a downturn.
On proof and pudding
Consider the returns (including dividend reinvestment) of these consumer staples since the beginning of 2001 (when the bubble had just begun to burst). Each company has returned far more than the 15.2% of the S&P 500.
|
Company |
Current Yield |
Return Since 2001 |
|---|---|---|
|
Altria Group |
4.1% |
192% |
|
Anheuser-Bush |
2.7% |
26% |
|
Colgate-Palmolive |
1.9% |
37% |
|
H.J. Heinz |
3.5% |
20% |
|
Johnson & Johnson |
2.5% |
44% |
|
Procter & Gamble |
2.1% |
97% |
Foolish words of wisdom
The stock market -- just like our economy -- moves in cycles. Recessions and downturns are just a fact of life. Building a balanced portfolio can help you protect your capital and even profit during these difficult times. Just remember two important factors:
- Dividend stocks can provide a special investment opportunity during economic recessions.
- Consumer staples (especially dividend-payers) are worth adding during downturns.
Learn more survival tactics for downturns in the Fool's monthly dividend newsletter, Income Investor. Co-advisors James Early and Andy Cross search for reliable companies that will remain high performers throughout all market cycles. You can try Income Investor free with a 30-day trial, with no obligation to subscribe. Just click here to learn more.
Claire Stephanic does not own any of the stocks mentioned in this article. Colgate-Palmolive and Anheuser-Busch are Inside Value recommendations. Heinz and Johnson & Johnson are Income Investor recommendations. The Fool has a disclosure policy.
