4 Stocks if You're Searching for Safety

08/15/2012 7:30 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

The slow-growth economy continues to grind on, and that keeps investors on the edge of their seats watching for something good—or bad—to help them decide what to do...but there's an easier and safer way, writes Stephen Leeb of The Complete Investor.

Arguably, there has never before been such a dichotomy in the financial world between potential growth and safety.

A featured article in Monday's Money & Investing section of The Wall Street Journal uses the word "stampede" to describe investors’ behavior in rushing to purchase high-quality corporate bonds. This translates into the ability of companies like International Business Machines (IBM), which recently offered a ten-year bond with a 2% yield, to issue debt where the after-tax charges (remember, payment on such debt is tax-deductible) are less than 2%.

This is significant in any number of ways. First and foremost, it certainly suggests an incredible fear of the future when investors are willing to accept such low returns just because of the putative safety of the issuing company.

The fact that at the present time this money generally winds up sitting in the coffers of these companies is further evidence of the pervasive fear that not only haunts the investing public, but also corporate America, as well.

As a sidebar, one of the most surprising statistics currently (though perhaps, on reflection, maybe not that surprising) is the yield on Swiss government bonds: if you want to buy a four-year Swiss note, you are going to have to pay the Swiss ten basis points a year for the privilege of holding your money, rather than the Swiss paying you for lending them money.

Yes, the signs of fear are utterly pervasive. But can we really blame investors? Probably not. For the first time in at least my own lifetime, policymakers have it within their power to destroy (or come close to destroying) Western civilization.

Right now, there are no assurances that Europe can recover without ultra-aggressive monetary easing. And clearly, the path of austerity, which so many continue to advocate, is the path to a repetition of what happened in the 1930s. Just consider Spain, where the unemployment rate is 25%. More austerity there means that a substantial portion of those unemployed would not be able to afford the most basic essentials of life.

And regarding the United States, you may have heard my excited interview this weekend on Fox Business, in which I argued that falling off a fiscal cliff could be falling into a black hole. Keep in mind that for the most part, the same folks who ran the key financial institutions in 2008 have kept their jobs. Need we say more?

Turning back to the corporations: with their seemingly unlimited stash of ultra-cheap funds, are they "all dressed-up with no place to go?"

Well, some, like IBM, which is a favorite of ours, have actually chosen to put this money to work by raising dividends and engaging in aggressive corporate purchases. Others have followed similar paths.

But what really strikes us as indicating the degree of fear out there is the extent to which so many companies are passing on acquisitions, which even under poor assumptions about the economy would still immediately boost their earnings and especially their cash-generating abilities.

We pointed out in an earlier piece that free cash flow yields are now about as high as they’ve ever been. So if a company like IBM takes the money it’s borrowing through issuing bonds—and on which it’s paying the taxman 1% or so—and then turns around and buys another company whose free cash flow yield is, say, 7%, it’s like putting your money in the bank and getting 6% after taxes.

And if the acquired company fits into your overall business structure...wow, you’re getting paid big time for enlarging your market share and gaining further traction in it!

But we haven’t really seen much of this. And it all comes back to fear. We haven’t done a survey, but we suspect that if we did, you would find the phrase "black swan" more frequently mentioned today than probably at any other time except during the height of the previous crisis.

It’s clear that this fear of a major unexpected negative event is scaring the bejesus out of everybody, from hardened corporate executives to nervous retirees who at this point are just looking to protect what they already have.

Two points: Clearly, if you don’t buy into the fear scenarios—i.e., if you do feel that policymakers from Merkel to the US President, the world’s central bankers, and the new leaders in China will somehow find a way forward—then stocks will explode.

If record levels of fear are not realized, and indeed the world becomes one that can sustain even slow growth, then the opportunities have never been greater. That’s the counterpoint to that old adage: "All problems have opportunities, and the greater the problem, the greater the opportunities."

On the other hand, if you are scared to death, whatever your age may be, we think an overlooked group of stocks may provide the greatest shelter. Here we’re talking about major defense companies: in particular, top pick Raytheon (RTN), along with General Dynamics (GD), Lockheed Martin (LMT), and Northrop Grumman (NOC).

If you invested equal amounts of money in all four stocks, the yield would amount to over 3.5%. Even more striking, the average free cash flow yield would be over 10%. Which means that after paying out their dividends these companies still have 7.5% left to buy back stocks and, if the spirit moves them, to make some acquisitions—which will almost certainly be in the defense area, too.

Why pick defense, especially in view of the fiscal cliff? Because, sad but true, it’s the one area—other than the happy results in the Olympics—in which the US has a clear and decided advantage over the rest of the world. It is the one area that we will “defend,” if you will, before everything else.

And just in case the world does manage to achieve some growth, these companies are hardly going to be left at the altar. Keep in mind that their free cash flow yields would allow them easy entry to many other related fields, from software to infrastructure.

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