Updated November 19th, 2015
Note: This article was originally titled ‘Bear Market Stocks: The Dividend Investors Guide’. It has been expanded and updated.
Table Of Contents
- What Is A Bear Market?
- Is Another Bear Market Ahead?
- The Mindset Needed To Beat Bear Markets
- Recession-Resistant Industries
- Bear Market Stock to Buy: Wal-Mart (WMT)
- Bear Market Stock to Buy: Johnson & Johnson (JNJ)
- Bear Market Stock to Buy: General Mills (GIS)
What Is A Bear Market?
The name ‘bear market’ invokes fear, and for good reason. Market-wide stock declines are called ‘bear markets’.
What is a bear market? Investopedia defines a bear market as:
A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20% or more in multiple broad market indexes, such as the Dow Jones Industrial Average or Standard & Poor’s 500 Index, over at least a two-month period, is considered an entry into a bear market.
The 20% decline threshold is what differentiates a bear market form a mere pullback or market correction.
- Pullback: Market loss of 0% to 10%
- Correction: Market loss of 10% to 20%
- Bear Market: Market Loss of 20% or more
Bear markets send shivers down the spines of timid investors… And for good reason. Seeing the value of your stocks falling is unnerving.
There is however a silver-lining (silver fur?) to bear markets.
Bear Markets provide investors with opportunities to buy stocks at bargain prices.
Dividend investors in particular should be happy to see bear markets. The lower stock prices go, the greater dividend yield new purchases will have.
Higher dividend yields mean a shorter dividend payback period. Your investments will pay you more when purchased in a bear market.
What stocks you purchase before a bear market matters. If you invest in high quality businesses that are likely to pay rising dividends through the bear market, then you will feel confident in your portfolio. You can also reinvest those dividends into stocks that have seen their prices fall significantly.
Here’s an example of the type of bargains available during recessions…
Aflac (AFL) stock briefly traded for dividend yields over 7% during 2009. The stock currently has a 2.4% dividend yield. Aflac stock looks cheap at current prices. Click here for detailed Aflac analysis. You can imagine how much of a steal the stock was when it yielded more than 7%.
This article examines bear markets in detail and provides 3 high quality dividend growth investment ideas to recession-proof your portfolio.
The reason there are only 3 is because markets are fairly pricey today. Most high quality businesses are currently overpriced. The 3 examined in this article all excel during recessions and are trading at fair or better prices today.
We are currently in the midst of a 6+ year bull market. The last bear market ended in March of 2009. Are we do for another bear market soon?
Is Another Bear Market Ahead?
The short answer to this question is yes.
There will always be another bear market. I am not certain of many things. I am certain that there will be another recession.
In 1929 (just before the Great Depression) economist Irving Fisher said the stock market had reached “Permanently high plateau”. He was wrong. The business cycle will not stop.
When the next recession will occur is another question entirely.
I don’t believe anyone can know exactly when a recession will occur. The economy (and the stock market) is a complex dynamic system. It is not predictable.
While it is impossible to know exactly when a recession will occur, we can analyze history to see if we are in a time period that has a higher probability of a recession occurring in the near future.
The first sign we are due for a recession is the high valuation of the stock market. The historical average price-to-earnings ratio of the S&P 500 is 15.6. It is currently trading for a price-to-earnings ratio of 22.0.
The stock market needs to decline by about 30% to reach its historical average. There is one caveat to this simple price-to-earnings analysis: interest rates are near historical lows.
Low interest rates cause higher valuations. When savings accounts are yielding near 0%, the stock market looks like a comparatively favorable investment. This increases demand, and the price-to-earnings multiple of the market. The Federal Reserve is signaling a rate hike, possibly in December of 2015. This could cause market values to fall, and the SP 500’s price-to-earnings ratio to fall.
In addition to potentially higher interest rates, the global economy is looking increasingly fragile. Japan, Europe, and the U.S. carry high levels of debt. Greece and Puerto Rico are on the verge of defaulting. China is propping up its struggling stock market with central bank funded purchases.
There’s no question there will be another bear market. The only question is when… It could be a week from now, a month, or 3 years.
The average time between recessions is around 100 months. The last recession ended about 70 months ago… I believe it is likely (though not certain) that we enter into another bear market in the next 3 years, and possibly much sooner.
Whenever the next bear market occurs, now is the time to psychologically prepare yourself for it.
The Mindset Needed To Beat Bear Markets
When the market falls, things get ugly in a hurry. You can see that from these 3 bear market stock charts from October of 2007 through March of 2009.
Here’s the S&P 500 (SPY)
And emerging markets (VWO)
And small cap stocks (VBR)
When markets fall, it is important to remember that stock price movements are not your enemy. In fact, you can benefit from a recession in the stock market.
It takes a self-assured investor to not panic during bear markets. The average individual investor sells during bear markets and buys during bull markets. This is completely backward – and it’s the primary reason why individual investors tend to do so poorly in the stock market.
When the next bear market hits – and hits your portfolio (and everyone else’s) hard, DO NOT SELL.
Instead, either hold your stocks (which is okay), or buy while bargains are available (which is much better).
Gene Walden of All Star Stocks has excellent advice on what to do in bear markets:
“So what should you do in a bear market? If you’re a long-term investor you do roughly the same thing in a bear market that you would in a bull market. You buy right through it. You make a continuing series of small bets. You select good quality companies and continue to build a position in those companies.”
For me, the key to being excited about bear markets is to invest in high quality dividend growth stocks with a long history of increasing dividends. These are stocks that have proven themselves in both bull and bear markets.
That doesn’t mean high quality dividend growth stocks don’t see price declines in bear markets… These stocks fall as well, but not as much, on average. Case-in-point, the Dividend Aristocrats Index fell 22% in 2008, while the S&P 500 fell 38%.
The image below shows the investing performance of the 10 most recession-proof Dividend Aristocrats:
As you can see, 2 Dividend Aristocrats (Wal-Mart and McDonald’s) actually posted double-digit positive returns during the 2008, while the S&P 500 fell 36%.
Specific industries tend to perform better than others during recessions. Among the worst performers are airlines, hotels, and casinos. People simply spend less extravagantly when times get tough.
6 of the most recession-proof industries are shown below, along with a brief description of what makes them resistant to recessions.
- Fast Food: People substitute more expensive restaurants for fast food during recessions.
- Health Care: You cannot ‘put off’ important medical procedures
- Discount retail: People look for bargains when income falls
- Waste Disposal: The garbage must be collected regardless of the overall economy
- Alcohol & Tobacco: People look for an escape when times get tough
- Essential Household Goods: Tissues, toilet paper, and other staples must be purchased
The 6 industries above have specific characteristics that help them to fight off the most severe effects of recessions. The 3 bear market stocks below are all worthy holds to protect your portfolio against recessions.
Bear Market Stock to Buy: Wal-Mart
From the beginning of 2007 to the end of 2009, the S&P 500 declined 15.9%. Wal-Mart (WMT), on the other hand, gained 19.1%.
Wal-Mart is an ideal bear market stock. The company is known to offer ‘everyday low prices’. When times get tough, consumers look for ways to get discounts on everyday household items. As a result, Wal-Mart tends to do well during recessions.
Just how well? The company’s earnings-per-share each year through the Great Recession of 2007 to 2009 are shown below:
- 2007 earnings-per-share of $3.16
- 2008 earnings-per-share of $3.42
- 2009 earnings-per-share of $3.66
Wal-Mart appears undervalued at current prices. The company is trading near its highest dividend yield ever. Currently, the stock is offering investors a 3.2% dividend yield.
The image below gives a 20 year history of Wal-Mart’s dividend yield to illustrate this point:
The company currently has a payout ratio of around 30%. Despite its low payout ratio, Wal-Mart will likely grow its dividend in line with earnings-per-share growth (instead of growing dividends faster) as the company is plowing money into future growth initiatives.
Despite recent weak recent results, Wal-Mart’s long-term growth prospects remain bright. Smaller layout Neighborhood Market stores are growing rapidly, as is e-commerce revenue. Additionally, comparable store sales are up in the United States.
If we do enter into another recession, Wal-Mart will likely benefit from increased store traffic and greater sales – and earnings. Regardless of whether we hit another bear market soon – now is the best time ever to buy Wal-Mart stock for dividend investors. The company’s combination of value, potential growth, and safety make it a favorite of The 8 Rules of Dividend Investing.
Wal-Mart is investing heavily in digital sales and better employee compensation. As a result, revenue and comparable store sales are up while profit margins are down.
Earnings-per-share increased 8.2% from 2007 to 2008, and 7.0% from 2008 to 2009. While these are not amazing numbers during a solid economy, they are amazing when one considers the overall economic climate. 2007 through 2009 was a time when many businesses were absolutely struggling – just look at General Motors (GM), Lehman Brothers, and AIG (AIG).
Bear Market Stock to Buy: Johnson & Johnson
Johnson & Johnson (JNJ) could have the best record of consistency of any publicly traded corporation.
The company has paid increasing dividends for 53 consecutive years, and has 31 consecutive years of adjusted earnings-per-share growth.
As one would expect from such a stable business, Johnson & Johnson marched through the Great Recession of 2007 to 2009 without missing a beat. The company saw earnings-per-share grow each year of the Great Recession:
- 2007 earnings-per-share of $4.15
- 2008 earnings-per-share of $4.57
- 2009 earnings-per-share of $4.63
Additionally, the company’s stock realized total returns of 5.8% (versus -15.9% for the S&P 500) from 2007 through 2009.
Johnson & Johnson is a high quality dividend growth stock. The company has compounded earnings-per-share and dividends at 5.6% and 8.9% a year, respectively, over the last decade.
Investors in Johnson & Johnson should expect slow and reliable growth of around 6% a year combined with the company’s current 2.9% dividend yield for total returns of around 9% a year.
Johnson & Johnson is currently trading at a forward price-to-earnings multiple of 16.0 – this is below the S&P 500’s forward price-to-earnings ratio of 17.3. Johnson & Johnson appears somewhat undervalued at this time relative to the S&P 500.
Bear Market Stock to Buy: General Mills
It’s rare for a stock to offer both market-beating total returns and low stock price volatility.
General Mills is just such a stock (as is Johnson & Johnson).
Over the last decade, General Mills has an annualized stock price standard deviation of 17.0%.
There are only 3 large cap stocks with 25 or more years of dividend payments without a reduction that have lower stock price volatility. They are listed below:
- Southern Company (SO) – stock price standard deviation of 16.8%
- Consolidated Edison (ED) – stock price standard deviation of 16.7%
- Johnson & Johnson (JNJ) – stock price standard deviation of 16.2%
General Mills stock price volatility is in the same league of high quality dividend paying utility businesses.
In addition, the company has one of (if not the most) impressive dividend histories of any stock.
General Mills has paid steady or increasing dividends for 115 years.
General Mills is one of the few businesses to grow earnings-per-share each year through the Great Recession of 2007 to 2009. The company’s earnings-per-share through the Great Recession are shown below:
- 2007 earnings-per-share of $2.30
- 2008 earnings-per-share of $2.50
- 2009 earnings-per-share of $2.78
The company’s well-branded consumer food products see demand increase during recessions. That’s because consumers tend to dine out less during recessions, and eat at home more.
You can see from the image above that the company expects to grow revenue in the low single digits; between 1% and 3% per year.
Operating income is expected to grow in the mid single digits; between 4% and 6% a year. This means the company is expecting margin improvements of around 3 percentage points a year.
Adjusted diluted earnings-per-share are expected to grow in the high single digits; between 7% and 9% a year.
In addition to this earnings-per-share growth, General Mills’ stock currently has a 3.1% dividend yield for an expected total return of 10% to 12% a year.
Long-term double-digit total returns are not an aberration for General Mills… They are the norm.
The company has averaged 11% total returns a year from 1995 to 2015. For comparison, the S&P 500 has generated total returns of 9% a year over the same time frame.
General Mills is currently trading for an adjusted price-to-earnings ratio of 18.9. The company appears to be trading at or below fair value, especially compared to the S&P 500’s current price-to-earnings ratio of 22.0.
Take Action Today
All 3 of the stocks in this article are either fairly valued or undervalued. All 3 perform exceptionally well during recessions. All 3 have long histories of dividend growth.
Investors looking to improve the performance of their portfolio during recessions should consider Wal-Mart, Johnson & Johnson, and General Mills.
Whether or not you buy these stocks today (or in the near future), it is critical that you take action by preparing yourself for the next bear market.
When the stock market declines by 20%, 30%, or more will you be ready?
You need to be.
Some investors will panic. Others know their portfolios are invested in high quality dividend growth stocks with a long history of paying steady or rising dividends through recessions.
These well-prepared investors will reinvest their dividends at very favorable prices during the next bear market. If they are still saving money, they will add to their portfolios rather than sell in fear.
Be mentally prepared for the next recession to realize stock market success when others are panicking.