After several years of a fairly smooth ride and tremendous rewards, stock market investors are paying more attention to the heightened volatility and greater risks they face…and asking whether the market has become too rocky for them to stomach.
Possible answer: Focus on stocks that are more likely to offer a steadier ride.
Bottom Line/Personal asked Rob Davies of Morningstar CPMS to use the research firm’s vast database to come up with 20 stocks that tend to hold up well in choppy markets and in down markets based on various measures of stability and resiliency. (The full list is below.) Morningstar CPMS specializes in screening and ranking stocks for institutional money managers and investment advisers.
Then we asked investment adviser Charles Sizemore, CFA, to analyze the list, which we are calling the Steady 20, and comment on how likely it is that the stocks will continue to fare well given the current economic, regulatory and market outlook and other factors.
The Steady 20 stocks were selected using the same software that allows money managers and financial advisers to design and test the performance of various strategies. Morningstar screened all US stocks trading on major markets. The screen was based on 10 key metrics, including beta, which measures how much a stock tends to rise and fall compared with the Standard & Poor’s 500 index, and measures of financial profitability and the ability to grow earnings steadily, such as return on equity and historical earnings variability. To avoid overly pricey stocks, Morningstar also screened for valuation measurements and eliminated stocks with price-to-earnings ratios (P/Es) that were very high compared with their long-term historical averages.
Result: A list of companies heavily involved in basic consumer goods and services as well as health care, utilities and financial services. Nineteen of the 20 companies pay an annual dividend, with a few recently yielding 4% or more, which is especially useful in down markets. Morningstar back-tested the Steady 20 as a portfolio to see how it would have fared from January 1, 2000, through September 30, 2015, with each stock equally weighted. While experiencing just half as much volatility as the overall market, on average, the Steady 20 excelled at minimizing losses. In the 2008 market meltdown, when the S&P 500 was down 37%, this portfolio would have lost just 10.6%. In fact, it never would have lost more than the index in any calendar quarter in 15-plus years. Even better, over the past decade, the Steady 20 portfolio would have delivered an average annualized return of 9.5% versus 6.8% for the S&P 500, and 12.5% versus 4% over the entire back-tested period.
Caution: These stocks have tended to win in the long run by losing less than the index in down markets. The Steady 20 beat the S&P 500 in rising markets only 40% of the time. And over the past five years of the bull market, the portfolio has trailed the index by an average of two percentage points a year. If you decide to consider some of these stocks for your portfolio, be disciplined—and don’t get discouraged—if your stocks lag when the market rallies.
Source: Rob Davies is an account manager with Morningstar CPMS, a Toronto-based subsidiary of the research firm Morningstar Inc. that helps institutional money managers and financial advisers design, test and track performance of equity strategies.
Even if you don’t want to buy all of the Steady 20 stocks, adding just a few might reduce the overall volatility of your stock portfolio. You could also select stocks that fit your particular needs. For example, if you want to focus on income, you could favor the stocks that pay higher yields.
Just keep in mind that some of these companies face greater challenges than others. I especially like the health-care stocks—Abbott Laboratories and Johnson & Johnson. Both are well-positioned to take advantage of the shifting health-care landscape including the Affordable Care Act and the aging US population. I also like the consumer-goods companies—Clorox, Procter & Gamble and Kimberly-Clark—all of which will benefit from the long-term growth of emerging markets.
On the other hand, some businesses in the Steady 20 are facing legal and/or regulatory risks that make me less enthusiastic about their prospects. For example, cigarette maker Altria Group still faces thousands of smoking-related lawsuits winding their way through state courts. And stocks of two companies—the subprime consumer lender World Acceptance Corp. and loan-servicing firm Navient Corp.—have been hurt recently because of news that the Consumer Financial Protection Bureau is investigating whether they violated consumer-protection laws, misled borrowers and imposed excessive fees on consumer loans. These companies may end up being cleared and see their stocks soar, but being in the government’s crosshairs makes it hard to maintain stock price stability.
Source: Charles Sizemore, CFA, is chief investment officer of Sizemore Capital Management, an investment advisory firm in Dallas. He is coauthor of Boom or Bust: Understanding and Profiting from a Changing Consumer Economy. CharlesSizemore.com
