Time to Go Defensive Due to Rising Geopolitical Risks?


Jan. 7 2020, Updated 10:24 a.m. ET

The US and Iran tensions have risen since the China trade war. We’ll have to see how Iran retaliates to the latest warnings from the US. However, broader markets could take an ugly turn amid growing uncertainties. Notably, we’re in the 12th year of the bull run. Broad market indexes are close to their all-time highs. The S&P 500 (SPY) and the Dow Jones Index (DIA) have risen almost 29% and 22%, respectively, in the last 12 months. The markets could make new highs or there might be a market downturn. Defensive investments might come into focus again due to increasing geopolitical tensions.

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Defensive investing

Investors can’t expect sizable returns from markets all the time. As a result, investors should rebalance portfolios for market downturns. Defensive investing involves taking a conservative approach and investing to minimize the risk of losing capital. One of the best ways to avoid risk is holding on to cash. However, cash wouldn’t generate any returns for the investor. Cash would lose value over the years due to inflation. As a result, investing in safe-havens like gold and bonds could be a form of defensive investing.

Dividend stocks: Utilities

Utilities generally have stable earnings and cash flows. Their cash flows aren’t as vulnerable to business or economic cycles. Notably, due to their earnings stability, they offer steady dividends as well. Utilities could be an effective hedge in case of a market downturn. Also, utility stocks are slow-moving stocks and can be useful for low-volatility portfolios.

Currently, utilities at large offer a dividend yield of 3%, which is higher than broader markets and the ten-year Treasury yield. They’re perceived as bond substitutes due to their stable dividends.

Also, utilities pay a large portion of their earnings in the form of dividends to shareholders. Interestingly, US utilities have an average payout ratio of approximately 70%. Their dividends play a huge role in driving shareholders’ returns over the long term.

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Top regulated utility Southern Company (SO) has one of the longest dividend payment histories among its peers. The company has increased dividends for the last 18 consecutive years. During the financial meltdown in 2008, Southern Company stock stayed relatively strong. When markets and other top tech stocks halved in value, Southern Company returned -11%. The company continued to increase dividends during the catastrophic financial crisis. To learn more, read How Southern Company Stock Has Done This Decade.

Consumer staples also provide an effective hedge amid a market downturn. Companies like Coca-Cola and Walmart have earnings that are less dependent or not dependent on economic cycles. Walmart offers a dividend yield of 1.8%, while Proctor & Gamble yields 2.4%.

REITs could be another form of defensive investing with relatively higher dividend yields. Currently, the Brookfield Property REIT and the Medical Properties Trust offer a yield of 7.3% and 5%, respectively.

Precious metals

Geopolitical tensions between the US and Iran have uplifted the traditional safe-havens—gold and crude oil. Investors look to gold when broader markets turn volatile. Interestingly, commodities have a low correlation to equities. For example, gold had a correlation of 0.07 with the S&P 500 in the last decade. If a broad market falls by 1%, gold will only decline by 0.07%.

According to Goldman Sachs, gold is a better hedge than oil given the latest geopolitical tensions, as reported by CNBC. Gold has started 2020 strong amid investors rushing towards safe-haven investments. Recently, gold prices reached a seven-year high. Gold prices are trading close to $1,567 as of 8:00 AM ET today.

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Investing through an ETF like the SPDR Gold Shares (GLD) could be a convenient way to get exposure to gold. Gold mining stocks also have a moderate positive correlation to gold prices. The VanEck Vectors Gold Miners ETF (GDX) offers exposure to gold miners globally. GDX has risen almost 37% in the last 12 months.

Barrick Gold and Newmont Goldcorp have risen 41% and 25%, respectively, during the same period. Read Could 2020 Be Even Better for Barrick Gold? to learn more.

Silver has also been shining brightly for the last few months. Overall, silver rallied approximately 40% in the last 12 months. The top stocks that have large exposure to silver are Wheaton Precious Metals and First Majestic Silver. The stocks rose more than 50% and 85% in the last 12 months, respectively.

Notably, investing comes with a risk and no portfolio could be perfect. There are times that a defensive portfolio could outperform or sometimes cash could be the king. However, a well-diversified portfolio could be more durable amid market volatility.


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