Tactical Defense Is Best Strategy for Volatile Stock Market
The stock market volatility of the past several months looks like it could stick around for a while, forcing investors to be ever more vigilant about how to position their portfolios.
“Stay defensive, be in low beta stocks, and achieve returns through dividends,” counsels Mark Tepper, a financial advisor with Strategic Wealth Partners in Seven Hills, Ohio.
Dividend-paying stocks are one of the more popular recipes for coping with uncertainty. U.S. companies are hoarding cash, making quarterly dividend payments to shareholders currently a much more reliable source of returns than capital appreciation.
Yet rapid sentiment shifts and potential bursts to the upside could leave buy-and-hold dividend investors flat-footed, says Ben Sullivan of Palisades Hudson Financial Group in Scarsdale, N.Y.
“High dividend stocks may be seen as more stable, but they will not grow as quickly in a recovery,’’ Sullivan says. “[If you] try to defend against one thing right now, you position yourself for future failure.”
The better course is to be tactical in your stock allocation, say analysts, taking tax losses in cyclical sectors that suffer the most in a bear market and investing the proceeds in more defensive sectors, such as health care and consumer staples. Stocks in these sectors tend to have lower betas, a measure of how closely an investment’s return matches that of the market.
The S&P 500, for instance, has a beta of 1.0, while General Mills, one of the few stocks to eke out a gain on Sept. 22, when U.S. markets fell more than 4 percent, has a beta of just 0.22. Low-beta stocks tend to be established, blue-chip companies with the market leadership and steady cash flow to weather economic downturns.
Low-beta stocks tend to produce smoother returns and better downside resistance during difficult markets, according to a 2008 study by the Schwab Center for Financial Research. While having a low beta doesn’t protect against losses, Schwab found it to be a valuable tool in helping investors gauge the expected risk of individual stocks and stock portfolios.
Wall Street appears to be giving more credence to beta. The first exchange traded fund (ETF) Goldman Sachs plans to roll out will focus on lower beta stocks, according to paperwork filed last month with the Securities and Exchange Commission.
An existing ETFthat targets low beta stocks is the PowerShares S&P 500 Low Volatility Portfolio. Owning the 100 stocks in the index with the lowest trailing volatility has enabled the ETF to outperform the overall index since its May 5 inception: losing just less than 6 percent, compared to a loss of 15 percent for the index.
Tepper is putting his clients in these types of stocks to avoid the wild market swings that have become the norm. He favors names like pharmaceutical maker Bristol-Myers Squibb , Duke Energy, and tobacco giant Altria.
Altria is a recession-proof stock due to its powerful pricing power. While cigarette sales are on the decline in a health-conscious U.S., Altria has been able to increase prices at a faster rate than sales have dropped.
“Our clients don’t expect us to be the hero [in these type of markets], but they want to be able to sleep at night,’’ Tepper says.
Food stocks, a subset of the staples sector, are another area that tends to hold up through tough times.
You can directly target food stocks through PowerShares Dynamic Food & Beverage ETF, which owns food, agriculture, and grocery companies. The ETF has held up better than the overall market year-to-date through Sept. 23, losing just over 2 percent versus a loss of 10 percent for the S&P 500.
For more general consumer staples exposure, advisors suggest the Consumer Staples Select Sector SPDR ETF.
Chris Hobart of Charlotte-based Hobart Financial Group sees a potential catalyst for coal stocks. That’s because pressure on Congress to balance the budget and get the economy moving again could sidetrack Environmental Protection Agency legislation aimed at coal miners. While he wouldn’t disclose names, Peabody Energy andArch Coal are good proxies for the sector.
For contrarian investors, offshore oil drillers look promising. The makers of drilling rigs have been beaten up worse than the overall oil sector but their fundamentals should continue to improve into 2012 and 2013, says Jefferies analyst Judson Bailey. Growing demand for rigs off the coasts of Brazil and West Africa could lead Bailey’s top picks Ensco, Noble, and Rowan Cos. to raise earnings estimates.
The stocks of companies providing essential services are the focus of Jamie Cox, an advisor with Harris Financial Group in Colonial Heights, Va.
These include utilities and telecom stocks. Among his favorites areDominion Resources, and Progress Energy, as well asAT&T and Verizon Communications , two stocks he considers undervalued because the Street isn’t taking into account the value of their networks.
“Boring is better right now,’’ says Cox, who favors owning stronger individual stocks over ETFs, especially in volatile markets like the current one. “This is one of those stratification moments when you want to pick the best [companies].”