There are plenty of pundits currently forecasting a crash — or at least a correction — in the stock market, and plenty of plausible reasons why they might be right: the length of the current bull run, the unwinding of QE and outlook for interest rates, toppish valuations in some sectors, a slew of profit warnings and geopolitical instability.
But this has been a much-anticipated correction, with the bears serially disappointed. Market timing is notoriously difficult, and just sitting out the market at the first whiff of trouble means missing out on potential gains. So what is the cautious investor to do?
To my mind, it’s time to be positioning defensively. That means:
- Holding some cash, maybe from ‘top-slicing’ winners, in anticipation of picking up bargains later;
- Being overweight in stocks that are in defensive sectors, and/or have a high and well-covered yield, and/or a low beta;
- Avoiding very high valuations and ‘story’ stocks — unless you have very high conviction.
Why beta?
‘Beta’ is the statistical measure of a stock’s sensitivity to market movements. Stocks with a beta of 1.0 generally move in line with the market, those with a higher beta exaggerate market movements whilst low betas move relatively less.
I’m wary of relying too much on automatic stock screens, and researching this article has revealed that different data providers calculate very different beta figures for the same stock. But screens are good for suggesting ideas, and I’ve picked out three low-beta stocks that are not always thought of as defensive.
Three picks
Indeed, Next (LSE: NXT) is in the fickle fashion sector. However, management has delivered a strong track record of turnover and profits through economic cycles, whilst superb financial management has seen the company virtually make a science of share buy-backs and special dividends.
Rolls-Royce (LSE: RR) (NASDAQOTH: RYCEY.US) is in a less volatile sector. Though defence markets are soft, growth is powered by the civilian aviation sector, which is in turn driven by increasing global wealth and mobility. Long lead times on commercial aerospace programmes, and long tails of service revenues, underpin the reliability of the company’s cash flow.
Pay TV has perhaps become a defensive product like alcohol, tobacco and gambling. That augurs well for British Sky Broadcasting (LSE: BSY) (NASDAQOTH: BSYBY.US). In a fast-moving sector, the consolidation of Sky Deutschland and Sky Italia puts the company in pole position to lead the sector in Europe. Market leadership, prodigious cash flow and the potential for M&A should help to support the share price.