When it comes to the stock market, sin is in.
So-called vice stocks in the tobacco, alcohol and defense industries generally are performing better than the overall market, which has moved in fits and starts in recent months. Looking forward, some analysts said that these companies are a good bet even when the world's economies begin growing again.
The Vice Fund (VICEX), which is invested in these three “sin” sectors, plus the gaming industry, was up 10% for the 12-month period ended Sept. 30, compared with the S&P 500's 8% rise.
Some individual stocks and funds within the sector fared even better over that time period: Tobacco seller Altria Group Inc. (MO) was up 34%, and the share price of The Boston Beer Co. Inc. (SAM), advanced 80%. The Fidelity Select Defense & Aerospace fund (FSDAX) was up 19%.
Sin stocks are considered “defensive” and tend to remain fairly stable under difficult economic conditions such as those that the nation has experienced during the past couple of years, said Jeff Middleswart, manager of the $74 million Vice Fund, which is offered by USA Mutuals Funds.
Demand for their products isn't going to plummet suddenly, and they don't need a lot of external financing, he said. Additionally, these companies are raising their dividends and trade at below-market price-earnings ratios, Mr. Middleswart said.
There is some misconception that because tobacco use in the United States isn't growing, those stocks have little growth potential. However, “there is huge growth opportunity” in emerging markets for tobacco, said Mr. Middleswart, who took over the fund in February.
Tobacco is a special “safe haven” during economic turbulence because it is addictive, said Philip Gorham, an equity analyst who covers the tobacco and alcohol sectors for Morningstar Inc. The industry can also make up for the decline in U.S. smokers through price increases.
“There's no sign of that relationship breaking down, even under these recessionary times,” Mr. Gorham said.
Mr. Middleswart is especially optimistic about defense contractors.
“Some of these are the cheapest stocks in the whole market and offer huge
dividend yields,” he said, mentioning Lockheed Martin Corp. (LMT) and Northrop Grumman Corp. (NOC). Even if Uncle Sam cuts defense spending, homeland security, maintenance and modernization projects will continue, Mr. Middleswart said.
Defense companies also have emerging-markets potential from countries such as Afghanistan, China, Israel and Japan, he said.
In the alcohol sector, there has been a shift among the consumers' choice of alcoholic beverages as personal budgets have tightened.
Overall, the challenging economic times have pushed more wine drinkers to enjoy quality beers and those who drink stronger spirits to buy the same liquor but down a grade, Mr. Gorham said. Craft brews such as Boston Beer's Samuel Adams and imports such as Stella Artois, which is produced by Anheuser-Busch InBev NV (BUD), have benefited from this position.
One vice industry that isn't doing well during the economic downturn, however, is gaming. Dan Ahrens, the Vice Fund's first manager and author of “Investing in Vice: The Recession-Proof Portfolio of Booze, Bets, Bombs and Butts” (St. Martins Press, 2004), said that gaming no longer works well for hedging the impact of a
recession, because in recent years, it has become too dependent on discretionary spending.
Casino operators' revenue and profits in the past decade have become more dependent on their hotel, restaurant, bar and entertainment businesses, and less on true gaming, said Mr. Ahrens, chief investment officer of AdvisorShares Investments LLC, which sponsors actively managed exchange-traded funds. Therefore, when the economy slowed and people had less money to spend on restaurants, bars and entertainment, gaming companies such as MGM Resorts International (MGM) suffered.
Most financial advisers aren't ready to recommend that clients jump into vice stocks, but some said that their clients already have some exposure to them.
Adviser Scott Whyte of Bloom Asset Management Inc. said that he recommends that clients who are worried about the impact of the
recession consider large- capitalization-value funds that emphasize consumer staples and often include tobacco and alcohol.
“These businesses continue to chug along, despite the fact that their growth is not very strong,” he said.
Of course, some clients reject investing in vice stocks on moral grounds. But “vice is in the eyes of the beholder,” Mr. Middleswart said.
Anyone who owns mutual funds likely has shares of Archer Daniels Midland Co. (ADM), The Coca-Cola Co. (KO) or McDonald's Corp. (MCD) — which have been associated with fattening the nation's children or polluting its air — or other companies whose products can be hazardous to your health, he said.
