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Printer Friendly View (with text zoom)BEING STREET SMART by Sy Harding Beware of Defensive Stocks! June 25, 2010. Just the thought of a double-dip less than a year after the
economy began pulling out of the last recession is agonizing. Just the thought
of another bear market in stocks so soon, with the S&P 500 still 30% below its
peaks of 2000 and 2007, is unbearable for many. Illustrating the emotional problem, in a recent e-mail
dialog, the well-known anchor of a financial TV show explained to me why he is
constantly arguing with analysts trying to warn investors, rather than letting
them have their say, why he is trying to have only a positive outlook for the
market presented instead of letting both sides be heard. He said, “My portfolio
is still 36% below where it was ten years ago, and I am probably in a state of
denial, unable to contemplate the possibility of another lost decade.” It’s likely that many investors are in the same boat, still
scarred by the back-to-back bear markets and hoping if they ignore the present
threat that it will go away. Unfortunately, the unpopular early warnings I have been
planting in this column for several months are beginning to bear fruit. The S&P
500 is down 12% from its April top. In last week’s column I noted that a
double-dip recession is no longer considered crazy talk, but has now become the
expectation of a number of credible economists, successful hedge-fund managers,
and analysts. The possibility of a double-dip became more obvious in the last
two weeks, with reports that retail sales unexpectedly declined in May, while
real estate sales collapsed. The outlook was not improved by the report Friday morning
that economic growth in the first quarter, originally reported at 3.2% (down
from 5.6% in the fourth quarter of 2009) was revised down to just 2.7%. The
consensus forecasts had already been that economic growth will slow in the
second half of the year. The downward revision of first quarter GDP, combined
with the dismal economic reports for May, will force economists to revise their
expectations for the second quarter, which ends next week, and for the rest of
the year. So this week has produced still more evidence that investors
need to at least be careful and take protective action to preserve their assets. Wall Street cannot bring itself to even recommend selling and
moving substantially to cash to preserve capital, let alone providing advice on
how to make profits in declining markets. The most common advice for declining markets is to simply
hold through whatever comes along. Those who have tried that in the past
recognize the folly of attempting it after giving up and bailing out with large
losses each time. Wall Street’s backup advice is to move to defensive stocks,
typically defined as companies that pay high dividends, and the big blue chip
companies with international operations, and companies with the wind at their
backs because even in recessions people still have to eat, drink, and take their
medicines. Wall Street says they won’t go down as much as the overall market. But is losing only 25% or 30% rather than 50% a credible way
to handle a bear market? And even Wall Street’s assurance that such ‘defensive’ stocks
will lose less in a bear market is not based on facts. Just look at what
happened to Alcoa, Coca-Cola, General Electric, Merck, Bristol Myers Squibb, in
fact almost all defensive Dow and S&P 500 stocks, in the last two bear markets.
Losses of as much as 65%. Utility stocks are also often defined as defensive stocks
since they typically pay high dividends. But the DJ Utilities Average plunged
61% in the 2000-2002 bear market, and 48% in the 2007-2009 bear market, about
the same as the overall market. Wall Street will have to change its bias if it expects
investors to begin to trust its advice again. Constant bullish advice to buy
only works in bull markets. When serious corrections or bear markets threaten, investors
need to pay attention and get their heads out of the sand. A good beginning
would be to look into ‘inverse’ etf’s and ‘inverse’ mutual funds, which are
designed to move up when the market moves down. There are close to a hundred
available, each tied to different market indexes and sectors. Inverse etf’s
include DOG, EFZ, PSQ. Inverse mutual funds include POTSX, BRPIX, RYURX. There
are also leveraged ‘inverse’ etf’s like QID, SDS, DXD, and leveraged inverse
mutual funds like URPIX, USPIX, RYTPX, which are leveraged and designed to move
up twice as much as the underlying market index or sector moves down. Making gains in down markets is a much better feeling than
simply losing less by buying ‘defensive’ stocks.
Sy Harding is
president of Asset Management Research Corp, and editor of
www.StreetSmartReport.com,
and the
free daily market blog,
www.streetsmartpost.com. 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.
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