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BEING STREET SMART by Sy Harding Defensive Stocks Are Failing Again As Safe Havens!
In times of uncertainty, and in preparation for market declines, Wall Street’s
advice to investors is always the same.
The market cannot be ‘timed’, and cash does not pay enough interest to even keep
up with inflation. So investors need to remain fully invested and continue to
buy stocks, but can protect themselves by shifting to ‘defensive’ stocks and
sectors. The advice has always been the same. No matter what happens to the economy people will still have
to eat, drink, and take their medicines. So food, beverage, and drug companies
will continue to do well in an economic or market downturn. And the stocks of
utilities and other solid companies that pay high dividends will also do well
since the dividends will help offset a decline in the stock prices. They do not explain that although consumers will still have
to eat, drink, and take their medicines, investors will not have to continue to
value the earnings of those companies as highly as they did in a rising market.
Stocks that sell at 20 times earnings in the excitement of a rising market may
only sell for 12 times earnings by the time a correction has made investors more
fearful. So even though a company’s earnings continue to rise, its stock will
still be dragged down by the falling market. The same holds true for the high dividend payers. They also
do not escape the problem of investors not being willing to value their earnings
as highly as they did in a rising market. In fact, since defensive stocks and sectors are touted so
heavily by Wall Street near market tops, driving their prices to more
over-valued levels than other stocks, their subsequent declines often exceed the
decline of the rest of the market. It doesn’t take much research to check it out, but
unfortunately most investors aren’t inclined to bother. However, that is my job,
and here are the facts. Utilities are traditionally among the highest dividend
paying stocks. Yet the DJ Utilities Average plunged 60% in the 2000-2002 bear
market, considerably more than the 50% decline of the S&P 500. And it plunged
48% in the 2007-2009 bear market, not much different than the 50% decline of the
S&P 500. In lesser corrections the degree of safety promised for high
dividend paying stocks has been equally disappointing for those who accepted the
theory. In the summer correction of 2010 the S&P 500 declined 15%.
The DJ Utilities Average declined 13%. So far in the current correction, the S&P
500 is down 7.8%. But the DJ Utilities Average is down 11.6%. Likewise, the ten highest dividend-paying solid companies in
the 30-stock Dow are down an average of 18.9% in the current correction,
compared to the S&P 500 being down 7.8%. You could say that high-dividend payers have an added
incentive for selling in the current correction since one of the risks of the
‘fiscal cliff’ is that taxes on dividends might jump significantly. And that’s
true. But those same ten stocks plunged an average of 65.3% in the 2000-2002
bear market, and an average of 55.4% in the 2007-2009 bear, much worse than the
Dow and S&P 500. Meanwhile, we’re seeing the same historical pattern for the
‘still gotta eat, drink, and take their meds’ stocks. So far in the current pullback, while the S&P 500 is down
7.8%, the still gotta eat and drink category is holding up fairly well, although
Coca Cola (KO) is down 10.2% and PepsiCo is down 7.3%. But in the ‘still gotta take their meds’ category, while the
S&P 500 is down 7.8%, most major drug-makers are down more. Abbott Labs (ABT) is
down 12.4%, Bristol Myers (BMY) is down 14.8%, Eli Lilly (LLY) is down 14.6%,
and Merck (MRK) is down 10.7%. You can blame it on concerns about drug company profits
under Obamacare. But just as the high-dividend paying stocks plunged right along
with the rest of the market in the 2000-2002 and 2007-2009 bear markets, so too
did the drug-makers. Abbott Labs, Bristol Myers, Eli Lilly, and Merck, plunged
an average of 54.5% in the 2000-2002 bear market, and an average of 49.1% in the
2007-2009 bear. Several conclusions could be drawn from that history. The first is that there seems to be nothing to gain by
repositioning into the so-called defensive stocks or sectors. In fact, by doing
so one may come out the other side even more damaged than by holding onto
current holdings. Taking profits and moving to cash when risk is high would be
a much better strategy, even though the cash would earn nothing, since one keeps
the previous profits and can re-enter when the correction ends, rather than
having huge losses and needing the next bull market just to get back to even. And if the expected correction doesn’t materialize, the cost
is only some lost opportunity for more gains, not the actual painful losses
incurred by remaining fully invested and moving into so-called defensive stocks. Another approach, which I prefer, is that the best defense
is often a good offense. For instance, an ‘inverse’ etf or mutual fund designed to
move opposite to the S&P 500, like the Rydex Inverse S&P 500 fund (RYURX), or
the ProShares Short S&P 500 etf (SH) will gain roughly 20% if the S&P declines
20%, more in larger corrections. But
regardless of what decision is made, let’s be street smart and realize that
so-called ‘defensive stocks’ usually are not close to being so.
Sy Harding is president of Asset Management Research Corp, and editor of www.StreetSmartReport.com, and the free market blog, www.streetsmartpost.com. He can also be followed on Twitter @streetsmartpost Editors: You are welcome to quote from this article, or use it in its entirety, in your publication or on your website, as long as the credit in the above paragraph is also included. Readers are also welcome to e-mail, or print and snail-mail it to friends. These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance. Back to the Top Home Subscribe to RSS Feed
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