When expecting a market downturn many investors flock to so-called defensive stocks. But, are defensive stocks really safe? A swing trader might make a tidy profit shorting a utility stock when interest rates go up. US News writes that defensive stocks are not safe anymore.
Nervous investors should think twice before diving into so-called defensive stocks, especially those securities with high dividends. You might end up putting more risk into your portfolio than you realize.
Stocks that have less volatility than the overall market and pay higher dividends than most other stocks are often seen as a way to reduce risk in a portfolio. Traditionally, these are found in the defensive sectors, including consumer staples, utilities and health care.
There are two issues at play here. Stocks that pay a good dividend typically take a hit when rates go up and the Fed is likely to raise rates this month. And, many defensive stocks have already been bid up by the market. The advice given by US News is to look for growth, growth that will continue even if the market corrects.
Undervalued Is Good
Barron’s suggests low volatility stocks and undervalued stocks as a defensive strategy.
[Ernesto Ramos] achieves this “sleep-well” portfolio by looking for undervalued stocks that are beginning to regain investors’ favor, while also exhibiting low-risk properties of stable earnings, strong balance sheets, and conservative management. The fund just passed its third birthday and received a four-star rating from Morningstar, was No. 1 in its category (“low volatility”) for 2014, and is No. 6 year-to-date.
This is the approach that investors should take and these are stocks that traders probably want to avoid.
What to Trade?
A lot of money has flowed into a handful of stocks in the S&P 500 in the last year. The top ten stocks by market cap in the S&P 500 have gone up 14% in the last year and all of the rest have fallen 6%. If you are looking for bargains as well as defensive stocks don’t look to Apple or Amazon. If you are looking for stocks that might well correct heavily at some point take a look at Amazon.com which has a P/E ratio of 900! Market Watch says there are numbers that Amazon does not want you to see.
Amazon’s size cuts both ways. As the law of large numbers teaches us, a company will find it increasingly difficult to maintain its growth rate as it gets bigger. Why should Amazon be exempt from this law?
Nejat Seyhun, a finance professor at the University of Michigan, says there’s another factor that Amazon’s investors appear to be overlooking: The vigor with which other retailers will fight back to keep Amazon from grabbing as much market share as Wall Street expects.
A decade ago, of course, many of those other retailers were ill-prepared to exploit the potentials of Internet retailing. The $13.7 billion per year of sales by which Amazon increased its market share represented the low-lying fruit on those other retailers’ trees.
The point being that as a company gets larger growth becomes more difficult. But, timing the correction of Amazon might be difficult so one might consider put options instead of selling short. In any case always do your homework first before trading.