How to Make Money in a Volatile Market
Oct 1st 2011 4:34PM
Updated Oct 7th 2011 10:07AM
Wild market swings are becoming so common that my standard response is now a shrug of resignation. August was the sixth-wildest month of the past 30 years, and things haven't calmed down much since. The past quarter's worth of trading has seen the Dow Jones Industrial Index (INDEX: ^DJI) change by an average of 1.68% each day. So far in September we've seen average daily swings of 1.48%, which looks comparatively calm, like temporary relief in the middle of a hurricane. Another hurricane might still be on the horizon, so now would be a good time to sandbag your portfolio against the coming storms.
Don't get swept up
When I touch on the importance of beta, it's for a simple reason -- it offers an easy way to assess how wildly your stock will swing in relation to the rest of the market. In turbulent markets, high betas can make stock ownership simply nauseating. Ameriprise Financial, for example, is one of the most volatile stocks in the S&P 500 (INDEX: ^GSPC). It's gone up and down an average of 2.5% each day this month on its way to a beta of 1.98. Its seesaw performance hasn't helped it fend off the market swoon, since it's lagging the index by about 4%.
Over the past year, beta has been a reasonably good predictor of success, especially measured against broader market performance:
Performance (Past Year)
|Dow Jones Industrial Average||(7.08%)||3.50%|
|Entire S&P 500||(8.18%)||2.91%|
|S&P 500 stocks with beta < 0.5||0.85%||13.61%|
|S&P 500 stocks with beta < 1.0||(6.05%)||8.29%|
|S&P 500 stocks with beta > 1.0||(16.65%)||1.19%|
|S&P 500 stocks with beta > 1.5||(21.47%)||(4.57%)|
Sources: Finviz.com, Google Finance, and author's calculations.
The solution seems pretty simple, doesn't it? If you stick with low-beta stocks, you'll do better. If only it were that easy. There's no such thing as a foolproof method, but looking for a low beta can serve as the starting point in your search for the right stocks.
No ETFs track the under-0.5 group, as only 40 companies from the S&P 500 make the grade. There is an ETF, the Powershares S&P Low Volatility (NYS: SPLV) , that tracks the 100 lowest-beta stocks in that index. If you just want to dip your toe into the low-beta stream, this ETF would be a nice way to get started. One of the best things about many low-beta stocks is their consistent yield, and the ETF currently has a dividend yield of about 3.5%. For those who prefer individual stocks, I've also selected a few from the exclusive under-0.5 group that would be great additions to any defensive portfolio.
Classic defensive positions
Some of our favorite companies have classically low betas, like McDonald's (NYS: MCD) and Altria Group NYSE: MO). They've consistently beaten the Dow on price growth alone over the last decade, and that's before tabulating your returns with dividends reinvested. Both companies offer huge moats, consistent revenue streams, and long-term growth prospects.
Riders on the storm
One less visible member of the low-beta club is AutoZone (NYS: AZO) . It doesn't pay a dividend, but it's been growing rapidly, from 3,871 stores five years ago to 4,627 at the start of this year. Fool contributor Rick Munarriz thinks the company will keep growing, and I agree. These uncertain times make consumers reluctant to spend on big-ticket items like new cars, and companies like AutoZone offer a way to keep the old clunkers running. The economy's bound to pick up eventually, but until it does, any company that offers people ways to save money on major expenses is a fairly safe bet.
The flip side of fast growth is steady dividends, and you can't get much steadier than a utility, and there are two in the low-beta club. Southern Company (NYS: SO) narrowly bests Consolidated Edison (NYS: ED) for dividend yield, and analysts expect it to grow about twice as fast as ConEd over the coming five years. The two companies have grown at nearly the same pace this year, with ConEd holding a slight advantage in year-over-year stock-price growth while still maintaining a lower P/E. I'd go with higher growth expectations and pick SoCo for a defensive portfolio, but if you're looking for diverse defense, why not pick up a bit of both?
Beta isn't everything, but it can provide you with a good starting point when searching for safety. No stock is a sure thing, but doing the research can help you minimize risks and position your portfolio to explode when the next bull market inevitably charges in.
If you're thinking about giving one or more of these companies a place in your portfolio, you can stay on top of new information and fascinating facts by adding them to your Watchlist.
Editor's note: A previous version of this article incorrectly stated that the PowerShares D&P Low Volatility ETF paid no dividends. The Motley Fool regrets the error.
At the time this article was published The Motley Fool owns shares of Altria Group. Motley Fool newsletter services have recommended buying shares of McDonald's and Southern. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Alex Planes holds no financial stake in any company mentioned here. The Motley Fool has a disclosure policy.
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