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Utility Stocks Burn Bright

The tech-laden Nasdaq has always had a reputation of being a place where investors wanting higher returns could put their money--in return for higher risks. Events of the past few years have done nothing to dispel this impression, as many Nasdaq investors made fortunes in the late-'90s boom, then lost them in the crash that started in the spring of 2000.

But here's a surprise: The Standard & Poor's Utility index--a sector synonymous with dull--outperformed the Nasdaq Composite index from the end of 1995 through the end of the third quarter of 2001. Including dividends, the utility index showed a 7.8% average return, vs. 6.7% for the Nasdaq (chart).

That figure is no fluke. From the Nasdaq's inception in 1971 through the end of September, the high-tech index has had an 11.2% compound annualized rate of return, compared with 12% for the S&P utilities, according to Richard Bernstein and Lisa Kirschner, quantitative strategists at Merrill Lynch & Co. Utilities won the performance sweepstakes despite incurring less risk.

One reason utilities do so well is that they pay such high dividends--while many tech companies pay little or no dividend. The compounding of a steep dividend yield puts a strong floor under returns. Indeed, over the past two centuries, reinvested dividends have accounted for some 80% of the total return of stocks, after adjusting for inflation, according to data compiled by Wharton School's Jeremy J. Siegel. Thus, since 1995, the price appreciation of the utility index has been only half that of the Nasdaq, but dividends put utilities soundly ahead.

Market psychology comes into play, too. It's widely accepted that glamorous tech stocks offer the prospect of lush returns over the long haul. The problem is that the more people agree on this, the more money they pour in. That drives up tech prices and reduces long-term returns, argue Bernstein and Kirschner. By contrast, utilities aren't on anyone's list of sensational long-term capital-appreciation candidates. Wall Street ranks utility stocks low in forecasted growth year after year. But utilities' lack of popularity ends up keeping their price relatively low, considering their low risk and high dividends, and offering the possibility of greater capital appreciation later on. On Wall Street, the tortoise can beat the hare. It is an article of folk wisdom that heavy drinking increases during economic downturns: When people lose their jobs, they turn to alcohol. Yet economists have been somewhat skeptical. For one thing, overall consumption of alcoholic beverages typically doesn't rise much during recession. Moreover, economists argued that falling incomes during a downturn would make it harder for people to boost their purchases of drink.

A new paper by economists Christopher J. Ruhm of the University of North Carolina at Greensboro and William E. Black of Mathematica Policy Research takes a closer look at this seeming paradox. Based on a broad survey of more than 50,000 people each year from 1987 to 1999, they confirm that drinkers do reduce their consumption substantially in recessions. For example, a one-percentage-point increase in unemployment in a state decreased alcohol consumption by drinkers by more than 3%. A one-percentage-point rise in the national unemployment rate amplifies the effect, leading to an even larger reduction in alcohol consumption.

Most of that drop, say Ruhm and Black, occurs among heavy drinkers, the people who spend the most on liquor. That suggests that alcohol abuse is not likely to be an increased problem during recessions. Moreover, the two economists "uncover no evidence that drinking increases among persons becoming newly unemployed during bad economic times." Well before the terrorist attacks, the Midwest economy had turned markedly cooler. Its metal-bending manufacturers had slumped into a recession a full year ago, while farmers were getting by thanks only to hefty handouts from the government.

Now, as the rest of the nation begins to shiver, there are tentative signs that the Midwest, which slumped before the rest of the country, may be hit less hard by the latest downturn. On Oct. 30, the Conference Board reported that consumer confidence in October rose in the East North Central region--comprised of Illinois, Indiana, Michigan, Ohio, and Wisconsin--while falling in every other part of the country (chart). Meanwhile, the region's unemployment rate in September stood at 4.8%, below the national average of 4.9%.

William A. Strauss, senior economist at the Federal Reserve Bank of Chicago, says auto sales have already snapped back due to 0% financing packages. Because the region has less exposure to the computer industry, it may be spared some of the layoffs now bruising the West Coast, he says. And the tourism drought hits the Midwest less hard than other parts of the country.

Still, there are pockets where the ice is thickening. Jobless rates undoubtedly will rise in Chicago. Home-town giants Sears Roebuck, UAL, and McDonald's are all cutting head-office staffs, while the city's convention business is getting whacked by no-shows and cancellations. Chicago, says Diane C. Swonk, chief economist at Bank One Corp., "is the region's Achilles' heel."

Nevertheless, anyone who has suffered through a Midwest winter knows, of course, that a thaw will come sooner or later. And this time, it may arrive sooner than in most other regions.

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