Good Stocks for Bad Times

Illustration by Mario De Meyer

The world is rife with turmoil and volatility. But we’ve found 16 investments that offer a measure of stability in the midst of chaos.

When it comes to stocks, the only thing that feels certain right now is uncertainty. Perhaps rising wages, low debt, and pent-up housing demand will spark consumer spending and boost the economy and stock market alike. Maybe the war on ISIS and chaos in the Middle East will propel oil prices back to $100 a barrel and restore the once-lofty stock prices of drillers and military contractors. Or perhaps 2016 will be a repeat of 2015, plodding along with low-single-digit returns and investors waiting anxiously for a signal that it’s time to go all-in—or get out. With that in mind we went looking for safety: reasonably valued stocks of established, high-quality companies that don’t depend on a scalding economy to perform. No company is immune from outside forces, of course, but these selections offer a modicum of stability in an unstable world.


Airlines

Finally Flying High?

For decades the U.S. airline industry was the corporate equivalent of the Chicago Cubs—a loser of historic proportions. From 1977 through 2012, U.S. carriers posted a collective net loss of $49 billion, according to the trade group Airlines for America. The causes are well documented: An obsession with market share led them to fly planes that were 30% to 40% empty. Then 9/11 happened, fuel prices soared, and the Great Recession delivered a crippling blow. American AAL , US Airways LCC , Northwest NWA , United UAL , Continental, and Delta all cycled through bankruptcy.

BAD.12.15.15 1-airlinesU.S. Carriers Reenter the Black: After years of losses and bumpy skies, domestic airlines are ­making profits again.

Since then it’s been a happier tale: Reinvention! Profits! Consolidation has largely put the kibosh on damaging fare wars. Discipline has meant fuller airplanes. U.S. airlines had 8% more paying passengers in 2014 than a decade earlier despite operating 17% fewer flights.

The industry is squeezing more revenue out of each flight. Sure, travelers grouse about being nickel-and-dimed on extra-bag fees and $20 Wi-Fi (as they do about onboard crowding only slightly less dense than New York City subways at rush hour). But customers keep buying tickets and paying for the extras. “Passenger yield,” which measures revenue collected for every mile a passenger is flown, increased 35% from 2004 through 2014. The airlines have “done an absolutely brilliant job managing their businesses,” says Jonathan Golub, chief U.S. market strategist for RBC Capital Markets. Airlines have another thing going for them too: lower fuel prices.

Despite big gains for the sector—third-quarter earnings per share rose 45%, according to RBC—investors have kept the stocks grounded. The NYSE ARCA Airline index descended 12% through Nov. 8, vs. a 1% gain for the S&P 500. “You’re seeing results, but investors don’t buy it,” says Craig Hodges, portfolio manager of the $270 million Hodges Retail Fund.

The result: a buying opportunity. A diversified way to play the sector is the U.S. Global Jets ETF JETS . It holds shares of some 30 U.S. and foreign airlines, as well as a handful of aerospace players, such as Boeing and even General Dynamics. For individual stocks, the best choices are Delta DAL and Virgin America VA . Delta is one of Hodges’s holdings, and he considers it the best-managed airline in the industry. One example of Delta’s forward thinking: In 2012 it purchased its own oil refinery in order to reduce the markups it was paying oil refiners for jet fuel. “They’ve set themselves up to be the low-cost producer of jet fuel,” says Hodges.

PICKS:

  • U.S. Global Jets ETF
    2015 Stock Performance
  • +4.9%
  • Delta Airlines
  • -1.6%
  • Virgin America
  • -15.5%

Through the first nine months of 2015, Delta’s revenue rose 2% and expenses fell 9%, adding up to full liftoff—159%—in net income. Management has been using those earnings to buy back shares ($425 million worth in the most recent quarter) and increase dividends (Delta’s yield is 1.2%). Best of all, analysts expect earnings to increase 23% in 2016; with the stock now at $49, that equates to a forward price/earnings ratio of 8.5. Given that Delta’s median P/E in recent decades has been 11.6, that suggests the shares could reach a comfortable altitude.

Then there’s Virgin America, Richard Branson’s answer to low-fare leaders JetBlue JBLU and Southwest LUV . Virgin trades at a mere nine times projected 2016 earnings and has embarked on a growth plan that will increase seat capacity by 20% by the end of 2016. Deutsche Bank airlines analyst Michael Linenberg has a $44 price target for Virgin America.


Health Care

Rx for Robust Returns

BAD.12.15.15 2-drugs

Drug Approvals Rise

The Food and Drug Administration has been okaying an increasing number of pharmaceuticals, potentially auguring greater profits.

If you’re seeking safety, health care is probably the best prescription. Spending is increasing 6% a year, and new-drug approvals are on the rise. Despite that, S&P 500 health care stocks trade at 16 times forward earnings, vs. 17 for the S&P overall, even as analysts expect big health care stocks to improve earnings 10% over the next 12 months, compared to 7% for the broader index. The only seeming threat is the risk that anger over high drug prices will cause governmental action to rein them in.

For ETF investors, the Health Care Select SPDR XLV offers a broad selection of stalwarts and biotechs. Our two favorites in this category are Merck MRK and Biogen BIIB . Merck is still harmed by past R&D failures and patent losses on asthma blockbuster Singulair and other drugs. The stock trades at a modest 14 P/E and offers a 3.5% dividend yield. But Merck is more than a value play. New drugs, such as Januvia for diabetes and the Gardasil vaccine for human papillomavirus, are hits, and analysts are enthusiastic about potential treatments for Alzheimer’s, hepatitis, and lung cancer. Merck trades at $54. J.P. Morgan analyst Chris Schott has a $66 price target, convinced that Merck has “fundamentally changed.”

Between January and March 2015, investors, excited by an Alzheimer’s drug now in clinical trials, bid Biogen from $340 to $476 a share. Today it’s at $288, afflicted by slowing sales of its multiple-sclerosis drug Tecfidera. Biogen was concerned enough to announce an 11% workforce reduction, with some of the savings to be reinvested in Tecfidera marketing.

PICKS:

  • Health Care Select SPDR
    P/E (Average)
  • 17
  • Merck
  • 14
  • Biogen
  • 16

Still, the market’s reaction seems overblown. Biogen now trades at 16 times projected 2016 earnings, well below its five-year average P/E of 25 and the global biotech average of 35. Analysts expect 12% earnings growth for 2016, but it’s the more distant future that gleams. Biogen has three Alzheimer’s drugs in development; one, Aducanumab, has been shown in early trials to slow memory loss and remove the brain plaques that are a telltale sign of the disease. With 5 million Alzheimer’s patients in the U.S., says Cowen analyst Eric Schmidt, a hit drug could generate $20 billion in annual sales. He views Aducanumab as “one of the most exciting pipeline candidates in biotech.”


Revivals

Comeback Companies

Here are always values to be had among companies whose stocks have plunged. The trick, of course, is to identify those whose fall is temporary or whose stock has been excessively punished. DuPont DD , Volkswagen VLKAY , and Wynn Resorts WYNN are three 2015 losers we think are poised for rebound.

BAD.12.15.15 3-stock-perfCan’t Rebound Without a Fall: Volkswagen and Wynn have sustained major stock swoons, both based on problems that will eventually be solved. DuPont’s slip is less dramatic, but it remains a turnaround candidate.

Chemical giant DuPont is a turnaround story. Activist investor Nelson Peltz lost a proxy battle to get two seats on its board, but he may be winning the war. CEO Ellen Kullman, his nemesis, stepped down in September, and DuPont’s stock immediately shot up. Still, the shares are down 12% since March.

With a P/E of 20, DuPont isn’t cheap for a mature, old-economy stock. But John Linehan, manager of the T. Rowe Price Equity Income Fund, says its earnings have been depressed by overspending, particularly on R&D. He thinks $2 billion a year in costs can be wrung out of DuPont, which recorded $3.6 billion in net income in 2014. Linehan believes those savings would be worth an extra $20 a share, and he has faith in interim CEO Edward Breen to get the ball rolling. “Ed Breen cleaned up Tyco after [the fall of CEO Dennis Kozlowski],” says Linehan. “He split the company into several pieces, and in doing so unlocked a lot of shareholder value.” He expects a similar turnaround for DuPont, one that could include a sale of its struggling agricultural seed business.

The VW scandal, in which it admitted fitting 11 million diesel vehicles with software that can cheat nitrogen oxide emissions tests, is one of the biggest of the year. The fines and the cost of recalls will extend into the billions. However, there is a long history of big automakers rebounding from similar scandals, and VW’s business is fundamentally sound.

VW shares have crashed by 50% since April and trade at 0.6 times book value and 12 times 2016 earnings estimates (which have been dramatically reduced). Morningstar analyst Richard Hilgert considers the stock “oversold” and has a $42 target price—68% above where it trades now.

PICKS:

  • Dupont
    2015 Stock Performance
  • -9.0%
  • Volkswagen
  • -40.7%
  • Wynn Resorts
  • -58.1%

Bernstein analyst Max Warburton has argued that the scandal will have “very little impact” on VW’s sales or brand. Indeed, its North American sales increased 6.8% in October. One caveat: It’s impossible to predict the total cost of VW’s fines, recall costs, and civil liabilities, and it’s entirely possible the shares will fall further before they rebound. As a result, consider VW not a core holding but rather one aggressive investment in a well-diversified portfolio.

Wynn Resorts has fallen even more than VW, with the stock of the hotel and gaming giant tumbling from $149 to $61 a share in 2015. The negativity centers on the company’s 72% stake in Wynn Macau, a resort and casino on the Chinese coast near Hong Kong. An anticorruption campaign in China has big spenders fearful of visiting Macau casinos, and the Macau government is seeking to limit the number of gaming tables at Wynn’s operation—a move CEO Steve Wynn labeled “preposterous.”

Those troubles mean opportunity. Shares of the Macau unit, traded in Hong Kong, have declined 50% this year. Yet even after that, Wynn Resorts’ 72% stake in Wynn Macau is still worth $5.1 billion. To put that in perspective, Wynn Resorts has a market cap of $6.3 billion. Add the operating income Wynn Macau generates for the parent company, and investors in Wynn Resorts are basically getting Wynn’s U.S. operations for free, says Staley Cates, chief investment officer of Southeastern Asset Management, which owns shares of Wynn Resorts. He thinks the stock is worth double its current $61. Says Cates: “Steve Wynn is the best creator of value in the industry.”


The Fed

Banking on Rising Rates

Forecasting interest rates is a dangerous game. Nevertheless, every sign suggests that, this time, the Federal Reserve really, really, really means it and will start raising rates. Surprisingly strong wage and jobs growth are just the latest signs that the Fed needs to take action to tamp down inflation.

BAD.12.15.15 4-fed-fundsReady to Climb: After years at historically low levels, the Federal funds rate seems destined to rise.

Bank stocks should benefit. Traditional lenders profit on the difference between the cost at which they borrow money and the higher rate at which they lend it out. When rates are low, that spread—known as the net interest margin—gets compressed. Higher interest rates should translate to wider net interest margins and thus bigger profits for U.S. banks. One way to cash in on this is with an ETF. A good choice is SPDR S&P Bank ETF KBE , which emphasizes mid-size players rather than the megabanks perpetually in regulators’ crosshairs.

Two stocks poised to prosper are Charles Schwab SCHW and Capital One COF . Schwab is known primarily as a discount brokerage, but its trading commissions actually represent only 14% of its revenue. The much bigger portion comes from Schwab’s bank—one of the nation’s largest, with $100 billion in assets—and its money-market funds, where brokerage and advisory clients park their cash. A more normal rate environment would probably triple the profitability of the money-market funds.

PICKS:

  • SPDR S&P Bank ETF
    P/E (Average)
  • 15.3
  • Charles Schwab
  • 25
  • Capital One
  • 10

At first glance, Schwab’s shares seem pricey—a forward P/E of 25—but that’s actually a discount to its five-year average of 32. And analysts are projecting a 33% increase in profits next year. Margaret Vitrano, manager of the Clearbridge Large Cap Growth Fund, believes Schwab can sustain that success. “This is one of the stocks with the most leverage to the upside [when rates go up],” she says. “Plus, it’s a really good business.”

Capital One is modestly priced—at $77 a share, it has a P/E of 10—and offers a 2% dividend yield. Known for its credit cards, Capital One has been aggressively building its branch network and retail deposits. The wisdom of that will be apparent once rates start to rise, says Bill Nygren, manager of Oakmark Select. He thinks Capital One deserves a P/E closer to 15—which equates to $117 a share.


Energy

Oil Bubbles Back Up

Vadim Zlotnikov, the chief market strategist at AllianceBernstein, has low expectations for 2016. His prediction: 5% to 7% total returns for the S&P 500. In the past we’ve had technology or real estate or China pushing the market upward. “Today it’s just not clear where we are going to find the next growth driver,” he says.

His favorite idea in today’s environment: integrated oil stocks. They pay good dividends, and even with lower oil prices, those dividends are sustainable, as oil companies are spending less on drilling, exploration, and other capital expenditures. “On top of that you’re getting a free option in case there is a geopolitical event that causes oil prices to spike,” he says.

BAD.12.15.15 6-oil-bubbleBack to Balance: The gap between supply and demand is falling, suggesting a price rebound in the offing.

Given how low crude prices are—they’ve fallen from $105 to $40 a barrel since July 2014—it’s arguable whether you would even need global upheaval to cause a spike. Small shifts in supply or demand can have an outsize impact, and it’s clear that surging supply in North Dakota and Texas contributed to depressed prices. New drilling has slowed—but global oil consumption still increased 2% in the third quarter, according to the International Energy Association.

OPEC production is always a wild card, but the IEA expects non-OPEC output to decline in 2016. If overall production is flat, it wouldn’t require much demand growth for a 25% increase in the price of oil. That’s exactly what traders are predicting in the futures market for a year from now. “Demand [for oil] has been resilient, so it’s all about supply,” says Jeremy Zirin, chief U.S. equity market strategist at UBS. His prediction: Oil will rebound to at least $60 a barrel.

That’s hardly a boom price, but it would pay off for oil-stock bargain hunters. History shows time and again that Exxon Mobil XOM has been a winner. Yes, it has faced a double whammy, first with lower oil prices and then with heat over whether it misled on climate change (which the company denies). Sure, its profits have sagged, but for Exxon $20 billion in earnings is a bad year, and it will come back. In the meantime, investors are paid to wait: With the stock now down to $78 a share (from $97 in November 2014), its dividend yield is 3.7%.

PICKS:

  • Exxon Mobil
    Dividend Yield
  • 3.7%
  • TransCanada
  • 4.8%

Our other oil pick is more contrarian: TransCanada TRP . The Obama administration’s long-delayed decision to reject the company’s Keystone XL pipeline dragged the stock down all year, from $49 to $31 a share. Robert Kwan, energy analyst with RBC Dominion Securities, thinks that even without Keystone the stock could reach $59 in a year. Add the 4.8% dividend yield, and you’d have a 100% total return. Earnings have been up in 2015 because of higher oil-pipeline earnings, and Kwan anticipates 13% profit growth in 2016 as the company is slated to open two gas pipelines in Mexico.

“It’s a stock trading near its 52-week low,” says Hollis Ghobrial, an analyst with Westwood Funds, which has a sizable TransCanada position. “It’s got a 5% yield. Management has [implied] 8% to 10% dividend growth through 2017. And you’ve got some other pipeline projects—one in Mexico—underpinning that growth. There’s a lot to like.”


Technology

Big Tech Gets Bigger

BAD.12.15.15 6-tech-earnings

A Few Big Winners

A handful of leaders, such as Google, Apple, and Facebook (in blue), have far out-earned IBM, Oracle, Intel, and Qualcomm (black).

Unlike energy, the tech segment of the S&P 500 has thrived this year, returning 7%, vs. 3% for the index as a whole, and analysts expect that outperformance to continue in 2016. Still, you need to be choosy. The new generation of tech leaders is leaving the old-generation rivals in the dust. In the second and third quarters of 2015, the triumvirate of Apple AAPL , Google, and Facebook FB produced average earnings growth of 30% and 27%, respectively, whereas the earnings of old-tech stalwarts Cisco CSCO , IBM IBM , Intel INTL , and Qualcomm QCOM declined 16% and 15%. Says RBC’s Golub: “In tech, it’s winner take all.”

Our two favorite stocks here are Google GOOG and Microsoft MSFT . Of course, Microsoft epitomizes “old” tech, and the market assigns it the valuation of a venerable enterprise—a forward P/E of 17. But CEO Satya Nadella is repositioning Microsoft as a leader in cloud computing. “He’s done an incredible job in a short amount of time realigning the company,” says Steve Jue, senior analyst at Rainier Investment Management. And already Nadella has begun moving Microsoft’s stock price out of a decade-long funk. (Let’s not forget either: This is a company that is generating $12 billion in annual profits even in what in sports terms would be called a rebuilding period.)

What does Microsoft’s realignment look like? It means consumers are paying to download Office online rather than buying it in a box from Staples. It also means corporate clients are using Azure, Microsoft’s corporate cloud, for data storage, enterprise software, and other functions that were once handled in house. “A couple years ago Microsoft was considered yesterday’s technology,” says Vitrano of Clearbridge Large Cap Growth. “Now they’re a leader in the cloud.” The transformation isn’t complete, but in the meantime, Microsoft has been rewarding shareholders with dividend increases and stock repurchases—$7 billion worth in the most recent quarter. Its dividend yield: 3.1%.

With Google—officially now “Alphabet”—no transformation is necessary. It’s hitting on all cylinders: Third-quarter earnings soared 44%—the kind of growth rate that more than justifies the stock’s forward P/E of 20.

TOP PICKS:

  • Google
    P/E
  • 20
  • Microsoft
  • 17

Most of the growth and earnings are from the core search and advertising business. The stock market is virtually ignoring the value of the investments Google has made in businesses such as Nest and in technologies such as driverless cars. “A few years ago it looked like the investment Google was making in driverless cars was just burning money,” says Nygren of Oakmark Select. “Now it’s clear they’ve accumulated one of the best, if not the best, [intellectual-property] portfolios for driverless cars.”

That is also why Nygren believes the stock market is undervaluing the $128 a share in cash that Google has on its balance sheet. “The cash sitting on the balance sheet is being valued at nothing by the P/E investor,” says Nygren. “The fact is that Google is building a very interesting venture capital portfolio, so the only way that cash is worth zero is if you believe it will never be deployed into something valuable.”

For more features from Fortune’s Investor’s Guide, click here; for more online Investor’s Guide coverage, click here.

A version of this article appears in the December 15, 2015 issue of Fortune.

Correction: An earlier version of this article incorrectly stated that Virgin shares have a dividend yield of 4.9%. In fact, Virgin does not pay a dividend. Fortune regrets the error.

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