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Andrew Allentuck

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Sell in May and go away

Andrew Allentuck


The stock market has entered a time of doldrums, validating the old saying that one should "sell in May and go away." The S&P/TSX Composite swooned in the second half of June, begging the question of what one can do to get through a time of troubles for the stock market.

The first strategy, of course, is to shop for bargains. Trouble is, when the market is in a contractionary phase, most stocks head south. Buying in a falling market takes fortitude; it's not for everyone.

Some stocks can thrive in bear markets, says Norman Levine, Managing Director at Portfolio Management Corporation in Toronto. A widely respected stock picker, he notes that the usual survival stocks - beer, smokes and replacement auto parts - should do better than many cyclicals. But he cautions, "when they raid the henhouse, they take all the chickens with them." The implication, of course, is that no stock is immune from a downturn.

At the top of his list is Genuine Parts Co., (GPC-NYSE), a U.S. company that makes replacement auto parts. In economic downturns, new car sales suffer and owners put money into maintenance. That logic has propelled the company, which markets products under such brands as NAPA, to returns double those of the S&P 500 since 1978, Levine adds. Recently traded at $49 (U.S.), it is priced at 17.5 times trailing earnings and has a 3.0 per cent yield.

Smoking seems to be immune from economic downtrends. Indeed, when people are unemployed and have more time on their hands, they may smoke more. But picking tobacco stocks, a consumer staple with exceptional customer loyalty, is an art. Mr. Levine says he would be U.S. tobacco manufacturer Altria (MO-NYSE) for growth or Canadian manufacturer Rothmans Inc. (ROC-TSX), for its 5.8-per-cent yield.

Other traditional consumer staples include grocery stores. The biggest grocery chain in Canada, Loblaw Companies (L-TSX) is in trouble and is not on his shopping list, Levine says. "Canadian grocers are in the early stages of taking on Wal-Mart. Loblaw decided to fight in general merchandise and has lost. But in the U.S., Kroger (KR-NYSE) won the battle by using its strength in food. Kroger reported a 54.9-per-cent increase in earnings a share for the 12 months ended Jan. 31, 2007.

Other plays on consumer staples focus on drugstores. In Canada, Shoppers Drug Mart Corp. (SC-TSX) has established a strong market share. In the U.S., Walgreen Company (WAG-NYSE) has an entrenched position. Drugstores are a safer play than drug makers that have high litigation risk, notes Jackee Pratt, a portfolio manager at Mavrix Fund Management Inc in Toronto. Other plays in staples include Kellogg Company, (K-NYSE), the world's largest maker of breakfast cereals. Breakfast cereals ought to be immune from economic downturns, she reasons. Beer, the final sector in the trio of recession-proof stocks, is a tough call. "I would not buy any Canadian brewer," Mr. Levine explains. Only two breweries remain public - Big Rock Income Trust (BR.UN-TSX), which is a western Canadian brand, and Brick Brewing Co. (BBB-TSX) in Waterloo, Ontario. They may be taken out, but their future is unclear, he adds. In the U.S., he says, Budweiser (Anheuser-Busch Companies Inc. - BUD-NYSE) is not on his list of stocks to buy. Beer consumption is declining as wines expand their market share, he notes. In any case, low-end beer is about tight margins and profits are elusive.

Should the summer stock market correction turn into a recession, then conventional wisdom might be turned on its head. Bargain hunting for financial services stocks, for example, might be unwise if bank and insurance company shares are going to fall further.

Some stocks would likely be able to buck the trend of falling prices. Pawn shops have gone out of the shadows of seedy neighbourhoods and turned downright respectable. The unemployed may have to hock their silverware, but shrewd buyers can Pick up shares in major U.S. pawnshop chains including First Cash Financial Services Inc (FCFS-NASDAQ), EZCorp Inc. (EZPW-NASDAQ), and Cash America International (CHS-NYSE). The pawn sector was moribund until 2003, when it suddenly began to produce substantial growth. Of the three companies, First Cash is the performance leader with earnings per share up by 60 per cent for the 12 months ended March 31, 2007.

One cannot say that the hock shops will be the winners in any serious downturn.

"Globalization has penalized low-end consumers, but the high-end consumer has been a winner," says Bruce Murray, executive vice president at money manager McLean Budden Inc. in Toronto. "It is the guy who makes the car and nails the house together who is being hurt." That reasoning supports holding Diageo Plc (DEO-NYSE), the global drinks conglomerate, even while selling brewers.

The final alternative is just to wait out the correction. Canadian banks have a firm grasp on the economy and seem able to survive any storm. Global financial services companies like Sun Life Financial Inc. (SLF-TSX) and Manulife Financial Corp. (MFC-TSX) are no longer dependent on the fortunes of Canada.

In the end, one can trade on a short-term trend or stick with a buy and hold strategy based on companies with the strength to ride out the storm. Survival stocks are specialized plays. They're not for everyone, but they can help ride out a storm.

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

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