Fiscal Cliff; Investors Should Be Prepared For The Worst

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The U.S. equity market saw a huge sell-off following the Presidential election last week. All three benchmark indices tumbled more than 2% a day after Americans re-elected Barack Obama as President. The slide continued on Thursday.

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Dow Jones Falls Below 13,000 Mark on Fiscal Cliff Worries; Source; stockcharts.com

The sell-off was sparked by concerns over the looming threat of a “fiscal cliff.” The damage to the U.S. economy from automatic spending cuts and tax increases will be substantial. Most economists say that if lawmakers fail to reach an agreement on reducing the U.S. fiscal deficit then the implementation of automatic spending cuts and tax increases would push the U.S. economy back into another recession.

The Congressional Budget Office said in a report last week that the U.S. economy would contract 0.5% in 2013, while the unemployment rate will rise to 9.1% in the fourth quarter of 2013 if the fiscal cliff is not averted

Unlike the last time, policymakers have very few tools left to fight a recession. The Federal Reserve’s balance sheet is already stretched as it continues with a third round of quantitative easing and Operation Twist. There is no room to further cut interest rates.

With so much at stake, it is likely that lawmakers will reach some kind of deal before the year-end deadline. If a deal is not reached then lawmakers will very likely kick the can down the road. Whatever the case is, the next month-and-a-half is going to be extremely volatile for the market, to say the least.

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While most analysts think that policymakers will ultimately reach some sort of agreement before the deadline and avoid falling over the cliff, investors should be prepared for the worst outcome. This means risk-off trade until there is certainty that the cliff will be averted.

The best bet for equity investors right now is dividend-paying companies with stable earnings, cash flows, and solid balance sheets. The anticipated volatility could also present some bargains for investors. Here are some companies that might keep investors from falling down that cliff; note that they all belong to the well-known Dogs of the Dow set of dividend stocks, as I discussed in another article.

AT&T (NYSE: T)

The wireless carrier currently has a dividend yield of 5.37%. AT&T shares have gained 10.91% year to date, outperforming the S&P 500.

In the most recently reported quarter (Q3), AT&T had consolidated revenue of $31.5 billion, which was flat compared to the same period in the previous year.  The company’s total wireless revenue rose 6.6% in the third quarter, and its smartphone sales in the quarter totaled 6.1 million. The company also registered its strongest postpaid wireless subscriber average monthly revenues per user (ARPU) growth in the last six quarters. AT&T’s postpaid churn for the quarter was 1.08%, compared to 1.15% reported for the same period in the previous year.

In the third quarter, the company’s postpaid net additions were 151,000, down from 319,000 additions last year. The postpaid results were impacted by iPhone 5 inventory constraints.

AT&T had a record free cash flow of $6.5 billion in the third quarter.

Verizon (NYSE: VZ)

AT&T’s rival Verizon also has a very high dividend yield of 4.83%. VZ has gained 6.28% so far this year, under-performing the S&P 500.

Last month Verizon reported the third consecutive quarter of double digit earnings growth. The company reported third-quarter earnings per share of $0.56, representing an increase of 14.3% over the same period in the previous year. The company’s adjusted earnings for the quarter were $0.64 per share.

Verizon’s total operating revenue for the quarter stood at $29 billion, up 3.9% over the same period in the previous year. Consolidated operating income was $5.5 billion in the third quarter of 2012. The company has generated free cash flow of $13.4 billion in the first nine months of 2012.

Verizon's wireless unit, Verizon Wireless, reported a 7.3% increase in total revenue in the third quarter. The company’s postpaid customer additions for the quarter were 1.54 million, well above the consensus forecast and significantly above AT&T’s net postpaid customer additions in the quarter.

Merck (NYSE: MRK)

Global healthcare company Merck currently has a dividend yield of 3.81%. Shares of Merck have outperformed the S&P 500 this year, gaining 16.84% YTD.

Last month Merck reported net income of $1.73 billion, or $0.56 per share for the third quarter of 2012, up from $1.69 billion, or $0.55 per share reported for the same period in the previous year. The company’s non-GAAP net income for the quarter was $2.93 billion, or $0.95 per share, compared to $2.91 billion, or $0.94 per share reported last year. Merck’s adjusted earnings for the quarter beat consensus forecast of $0.92 per share.

Wait and Watch Approach

While investing in companies with solid balance sheets is the best way to survive a volatile market, investors should remain cautious in the next few weeks. If the example of the debt ceiling deadlock of 2011, which resulted in huge sell-off in equity markets and downgrade of U.S. credit rating for the first time in the country’s history, is anything to go by, then it would be advisable for investors to remain on the sidelines until there is some clarity on the fiscal cliff issue. 

Know What You Own

For nearly 100 years, Merck’s cutting-edge research has led to a number of medical breakthroughs. Today, however, this pharma stalwart is staring down a steep patent cliff and facing generic competition for its top-selling drug. Will Merck crumble under its own weight, or will it continue to pay dividends to investors for another century? To find out if this pharma giant has the stamina to keep its Bunsen burners alight, grab your copy of The Motley Fool’s brand new premium research report today. Senior Biotech Analyst Brian Orelli, Ph.D. walks you through both the opportunities and threats facing Merck, and the report comes with a full 12 months of updates. Claim your copy now by clicking here.


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