Navigate QE2 Volatility With Freeport, Exxon

BOSTON (TheStreet) -- Freeport-McMoRan (FCX), Exxon Mobil (XOM) and 3M (MMM) are among stocks that would weather the volatility of additional quantitative easing, says Paul Nolte, a managing director at Dearborn Partners.

In minutes released yesterday from its last interest-rate policy meeting, the Federal Reserve all but cleared the way for another round of so-called quantitative easing -- purchasing government bonds and securities to stimulate the economy -- although members of the Federal Open Market Committee differed in opinions on the timing of any move.

Quantitative easing is designed to indirectly pump money into equities and the economy. By boosting reserves of banks and other financial institutions, the Fed would create a wealth effect, sparking a stock-market rally.
Paul Nolte
Paul Nolte, managing director with Dearborn Partners.

But some fund managers are sounding caution on a QE2 rally, as the second round of quantitavtive easing is informally known.

Dearborn Partners' Nolte says the Fed is walking a tightrope with QE2, arguing that the U.S. is "essentially monetizing our debt" and that money will find its way into the financial markets and various assets, but not into the economy as intended.

"If things continue to go poorly in the economy, the Fed is then pressured to do more on QE," Nolte says. "If the economy picks up and we see unemployment fall below 8% and we get job growth, that will be bad because the Fed will pull back and the money flow will dry up. Gold will fall, equity markets will fall, and interest rates will go higher."

This type of market uncertainty requires a long-term strategy, Nolte says.

"You want to buy high quality in this environment because if things do go bad, these types of companies will continue to perform well even in a poor environment," Nolte says. "Plus you get the added bonus of a decent dividend in many cases. Global exposure is also what you want, whether the company is domiciled in the U.S. or elsewhere."

In the short term, the monetary easing will have a "deleterious impact" on the dollar, Nolte says. A lower dollar will push up commodity prices, such as gold, corn and wheat. A weaker dollar would boost equities and extend the rally in bonds. That can be a risk to this type of strategy due to the defensive characteristics of the stock picks.

Nolte says stocks like Exxon and 3M "only provide a hedge in the fact that you're looking at industry leaders. Like we saw in 2008, these stocks will decline less than the overall market. They won't recover as fast, but you won't have the big downside, either."

The strategy has worked well for Nolte and Dearborn Partners, which has about $2 billion in assets under management. Much of that is devoted to institutional all-equity portfolios. The firm uses the S&P 500 as its benchmark and, while it is trailing over the past 12 month, it has beaten that benchmark over two to five years.

"We're tilted toward economic growth," Nolte says. "If you look at our portfolios, we're overweight the industrial names and to a certain extent with basic materials. We're underweight some of the more defensive names, like consumer stocks and health care."

Even if QE2 sparks a rally in equities, Nolte says investors may be better off finding a safe haven in the following five stocks, which are owned by portfolios managed by Dearborn Partners.

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3M ( MMM)

Company Profile: 3M sells consumer products, including Scotch Tape, Post-it Notes and Scotchgard.

Closing Price: $88.15 (Oct. 12)

Dividend Yield: 2.4%

Nolte's Take: "You have good revenue growth and good earnings growth. There is continued innovation with 3M. There's a good dividend with an increasing yield, and they have a great history of raising their dividend. You're going to have a rising income stream over time."

Financial Metrics: 3M has a price-to-earnings ratio of 16 over the trailing 12 months, slightly below the industry average and the S&P 500. 3M has a forward P/E ratio of 13.9, in line with the S&P 500's.

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Freeport-McMoRan ( FCX)

Company Profile: Freeport-McMoRan mines for copper, gold and molybdenum.

Closing Price: $95.43 (Oct. 12)

Dividend Yield: 1.3%

Nolte's Take: "Here you have a smaller dividend and they don't raise it as often, but it is a play on a lot of the input materials for the economy. It's a play on copper and less of a play on gold. That's what we're aiming for with Freeport-McMoRan. The stock has been very volatile -- it is now above $90 and it was near $60 not that long ago. It's already had a pretty good run, but we're looking out over the long term."

Financial Metrics: Freeport-McMoRan has a price-to-earnings ratio of 12.5 over the trailing 12 months, below the industry average and the S&P 500's. The company has a forward P/E ratio of 10.9 based on 2011 estimates, also below the S&P 500's.

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Exxon Mobil ( XOM)

Company Profile: Exxon Mobil is the largest U.S. oil company.

Closing Price: $64.70 (Oct. 12)

Dividend Yield: 2.7%

Nolte's Take: "They're one of the energy companies that really hasn't participated in the rally. They're getting discounted because of the acquisition of XTO Energy. They have huge reserves right now in natural gas, yet the market is discounting their ability to earn. Their size may actually hold them back, but the yield is nice."

Financial Metrics: Exxon Mobil has a price-to-earnings ratio of 12.5 over the trailing 12 months, below the industry average and the S&P 500. Exxon has a forward P/E ratio of 10.2 based on 2011 estimates, also below the S&P 500's.

Exxon has a PEG ratio, which measures value relative to projected growth over the next five years, of 0.9, indicating a slight discount to fair value.

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Nestle SA ( NSRGY)

Company Profile: Based in Switzerland, Nestle produces consumer goods, such as chocolate and confectionaries, powdered and liquid beverages, cereal, coffee, ice cream, prepared food, pet care and pharmaceutical products. Among its massive stable of brands are Purina, Lean Cuisine, PowerBar, Gerber, Carnation, Poland Spring, Taster's Choice and Butterfinger.

Closing Price: $54.72 (Oct. 12)

Dividend Yield: Nestle doesn't have a regular quarterly dividend established on its American depositary receipts (ADR). The company paid a special dividend of $1.38 a share in April, indicating a yield of roughly 2.5%.

Nolte's Take: "They've cleaned up their balance sheet, and they're sitting on a ton of cash right now. With zero debt, that may actually be in acquisition mode. They have global exposure to the consumers in the areas where people will always be buying, no matter what the economy is doing."

Financial Metrics: Both the trailing and forward P/E ratio for Nestle ADRs are around 16, in line with the S&P 500 over the past year but higher relative to 2011 earnings estimates for the benchmark index.

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Gilead Sciences ( GILD)

Company Profile: Gilead Sciences is a biopharmaceutical company that develops therapeutics in areas of unmet medical need, such as HIV/AIDS, liver disease and cardiovascular/metabolic and respiratory conditions. Its pipeline includes a "quad" single-dose pill of four drugs for patients with HIV/AIDS, currently in Phase III trials.

Closing Price: $36.11 (Oct. 12)

Dividend Yield: Gilead Sciences doesn't pay a dividend.

Nolte's Take: "This is out of the realm of the others as it doesn't pay a dividend, but valuations on it are very inexpensive. This company was beaten down into the $30 range even though they have good earnings and revenue growth. They're waiting for approval of their quad drug, which should provide pretty good revenue. I think investors are waiting for the drug approvals to come through."

Financial Metrics: Gildead has a price-to-earnings ratio of 11 over the trailing 12 months, well below the industry average and the S&P 500. Gilead has a forward P/E ratio of 9.3 based on 2011 estimates, also below the S&P 500's.

Gilead has a five-year expected PEG ratio of 0.75, indicating a discount to fair value.

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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