Since going defensive is not a free lunch, Russ says it’s important for investors to consider three aspects of their potential defensive postures.
Many investors continue to allocate to so-called “defensive” investments. However, not all defensives are created equal in all market scenarios. This is why, before going defensive, it’s important for investors to consider these three aspects of their potential defensive postures.
1. What they’re trying to defend against.
In allocating to defensive stocks, investors will want to be precise and differentiate between different types of risk. Investors who are trying to defend against a market correction, for instance, would probably want to think about investments that fit the traditional concept of a defensive stock, i.e. low beta stocks whose value should theoretically go down less when the market corrects.
Market Realist – Low beta stocks provide protection against falling markets
“Beta” is a measure of a fund’s sensitivity to market movements. The graph above shows beta, considering monthly returns for ten years, for Walmart Stores (WMT), Pfizer (PFE), Amgen (AMGN), and Duke Energy (DUK). These belong to the consumer staples (XLP), health care (XLV), biotech (IBB), and utilities (XLU) sectors, respectively. All are defensive stocks. As you can see, all four stocks have beta well below one. The beta of the market, in this case, the S&P 500 (SPY), is one by definition.
If a stock has a beta of 1.2, it could perform 20% better than the S&P 500 in up markets and 20% worse in down markets. Similarly, a stock with a beta of 0.9 indicates that the stock is expected to perform 10% worse than the market’s return during up markets and 10% better during down markets.
So, if you believe that the stock market could fall, you could try buying low beta stocks to defend yourself.