As is the case all too often, it seems investors have thrown the baby out with the bath water. Stocks have been selling off the last two months, and although we're likely to hear the bearish echoes for some time, there are some stocks we should consider wading into now - as opposed to merely thinking about them until a later date. (To understand more about the sell off, read Sympathy Selloff: An Investor's Guide).

A bear market and a recession are not the same thing. The sectors and stocks that i will discuss below were picked because:

  1. I think the bear market is close to being over, and
  2. I think the recession is just beginning.

The former eliminates the headwind, and the latter means defensive names are likely to be better money makers than growth-oriented industries.

The Happy Place
Fundamentals are at the root of all valuations, but eventually we need to be realistic and acknowledge that fundamentals are a bit meaningless right now. So, instead, I started my search from the top and worked my way down. My goal first was to find sectors and industries that were on the rise, and then ferret out the best of the best stocks. In almost all cases, the best of the best were part of an industry generally known to be defensive in nature (i.e. desirable in a tough economy). Since I had access to the data, I narrowed down my picks to the market cap level.

Here are the top performing sectors:

  1. Mid-Cap Education
  2. Mid-Cap General Merchandise Stores
  3. Small-Cap Personal Products
  4. Small-Cap Pharmaceuticals

Mid-Cap Education: Oriental Education and Technology Group
The S&P Mid-Cap Education Index is slightly in the last two weeks, although it is still in the hole (by 11.4%) over the last six months. However, I like the relative strength. I also can't ignore the fact that this group did something between March 28 and Sept. 12 that no other group could do: gain 65%. The S&P 500 was down 4.8% for that time frame.

Apollo Group (Nasdaq:APOL) would seem like the no-brainer choice here, but there's a fast growing Chinese contender called New Oriental Education and Technology Group (NYSE:EDU) with even better numbers. Should a recession dig into those results a little (and I feel it will), there's still a lot of wiggle room when your net margins are around 25% for the trailing twelve months, and you're growing revenue by 32.1% quarter on quarter.

Mid-Cap General Merchandise: Kohl's
I have long argued against putting Wal-Mart (NYSE:WMT) on the industry pedestal; the size of its market share has added a few pounds of bloat to the numbers. The smaller players are also the lean and mean players.

With its 7.7% gain over the last six months, The S&P Mid-Cap General Merchandise Store Index led me back to Kohl's (NYSE:KSS) - a company I roasted in August for a P/E ratio of just under 15. With a P/E of about 10 now, however, I'm being swayed, particularly when Wal-Mart's is still around 15. Kohl's recently warned it would fall short in Q3 thanks to cash-strapped consumers, but with a P/E of 10, those ill-effects seem to be already priced into the stock.

Small-Cap Personal Products: Herbalife
As obvious as it is to mention that soap and toothpaste never fall out of favor, the truth is they really don't. That may be why the S&P Small Cap Personal Products Index is up 8.1% for the last three weeks. Investors are down-shifting into defensive arenas.

The standard choice is Procter & Gamble (NYSE:PG). However, if you want something that packs a little more punch, take a look at Herbalife (NYSE:HLF). The chart's a mess right now, but not because the company is drying up. To the contrary, the international expansion is going strong. Its weight management and energy/fitness product line aren't recession-sensitive, but even if it can only earn half of what analysts expect in 2009, we're still looking at a P/E of about 7.

Small-Cap Pharmaceuticals: Amgen
A gain of 5.3% over the last six months (how much the S&P Small Cap Pharmaceutical index has risen) doesn't sound like much, until you factor in the S&P 500's 38.7% loss.

My individual pick is Amgen (Nasdaq:AMGN). Shares have defied the odds since October 10, by actually moving higher while the overall market was taking a beating.

Final Thoughts
These are far from the only defensive picks that recession-worried investors could consider right now. However, these four look like the best bets within their respective groups. On the flipside, the market has verified one thing lately: fear can take over in a matter of minutes, and send even the best of stocks lower. As such, even these benign names are best kept on a short leash.

To learn more, read Guard Your Portfolio With Defensive Stocks.

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Tickers in this Article: AMGN, EDU, KSS, HLF, WMT, APOL, PG

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