What to Do Now to Protect Yourself

Is it time for stock investors to become more cautious? After all, the bull market, which is more than six years old, has seen the Standard & Poor’s 500 stock index more than triple—while over the past 60 years, previous bull markets have lasted an average of only about four years and seen gains averaging 137%. Some analysts say that once the Federal Reserve starts raising interest rates later this year (the common assumption), this bull market will end and a bear market will begin, while others say interest rates and inflation will remain low enough—and the economy strong enough—that the bull will continue to push ahead.

Investment expert Kelley Wright says he can’t predict exactly when a bear market will debut—but when we spoke with him recently, he told Bottom Line/Personal that cautious investors should start shifting their stock portfolios into stocks that can limit declines in a downturn…or investors should at least identify those defensive stocks now. We asked Wright to tell us how he picks great bear market stocks and to name his favorites…

CHECK DIVIDENDS AND PAST PERFORMANCE

Investors are far better off sticking with their long-term allocations to stocks through bear markets rather than trying to jump out of the market to avoid downturns and then back in to catch the next big rally. That strategy rarely works because it is too hard to time the market. However, in rough times, you don’t have to take unnecessary risks by investing in low-quality or aggressive growth stocks that are likely to suffer the worst losses. Over the past three decades, I have found that companies with certain characteristics can help protect your portfolio in bear markets. Their shares typically lose 30% to 50% less than the S&P 500, making it easier for investors to recover. Look for…

Large-cap blue chips in defensive sectors such as health care, consumer staples and discount retailing. The best of these companies have long histories of earnings growth no matter what’s going on in the economy or market.

Solid dividends payouts. Since 1972, dividend payers in the S&P 500 have outperformed nonpayers by 12.5 percentage points, on average, in bear markets.

Strong relative performance in past bear markets, including the bursting of the tech bubble from 2000 to 2002, when the S&P 500 lost 47%, and the 2007–2009 bear, when it fell 55%.

Cheap stock prices. Many bear market stalwarts that I have relied on in the past, such as Johnson & Johnson and Clorox, have done so well recently that their stocks are overvalued. So they may not provide the same protection in a down market as in the past. I want blue chips that are selling cheaply, even if it means that the companies have some problems. That may seem counterintuitive for stocks that are supposed to hold up in a bear market, but it’s OK as long as the companies’ problems are short term and are being addressed by management.

MY FAVORITES NOW

If you can’t accept the possibility that your stock holdings could lose one-third of their value in the next few years (the average drop in a bear market), consider selling your most aggressive and/or overvalued stocks now and moving into the ­following…

Wal-Mart Stores (WMT). Low-cost retailers tend to thrive in uncertain economic times. And few competitors are able to undercut the prices at Walmart. The company is facing plenty of challenges right now, including sluggish growth and public criticism that it doesn’t pay adequate wages. But new CEO Doug McMillon has agreed to raise wages for 500,000 employees, about 40% of the chain’s US workforce, as a way to drive productivity. He also is moving into big cities and urban markets by creating hundreds of Walmart Neighborhood Markets, just one-fifth the size of its supercenters. Recent yield: 2.4%. Past bear market performance: +7.4% in 2007–2009…–20% in 2000–2002.* Recent share price: $78.03.

CVS Health (CVS). The health-care ­industry has years of steady growth ahead of it, thanks to an aging population and wider US insurance coverage through the Affordable Care Act. Most investors think of CVS as a retail pharmacy chain, but it’s taking major steps to become a full-service health-care provider. Recently, CVS rolled out Minute Clinics in more than 900 of its stores, where customers can see nurse practitioners for chronic conditions such as diabetes and high blood pressure. And the company has become the second-largest pharmacy benefits manager in the US, negotiating with drug ­com­panies and paying drug claims on behalf of private and government health plans. Recent yield: 1.4%. Past bear market performance: –38% in 2007–2009… –30% in 2000–2002. Recent share price: $99.36.

The TJX Companies (TJX). The largest off-price merchant for brand-name apparel and home goods in the US operates more than 3,400 stores (including some in Canada and Europe) under names including T.J. Maxx, Marshalls and HomeGoods. TJX’s business has thrived even in recessions. When department stores and other traditional retailers struggle, TJX gains access to more designer-name clothing at better prices. The result: Same-store sales have increased in every year but one in the past three decades. Recent yield: 1.3%. Past bear market performance: –25% in 2007–2009…+75% in 2000–2002. Recent share price: $66.19.

Philip Morris International (PM). Many investors are opposed to owning shares in a tobacco company, but for those who are interested, it is hard to ignore the stability of Philip Morris International, the world’s largest cigarette manufacturer outside of China, with seven of the world’s 15 top-selling brands, including Marlboro and L&M. For growth, Philip Morris relies largely on Asia, where its profits are expected to double to more than $10 billion by the year 2020. The company is struggling with the effects of the powerful US dollar right now. Since all its revenue comes from overseas, profits are translating into fewer US dollars. However, I don’t see this as a major issue in a market decline, because bear markets typically are caused by falling corporate earnings and recessions, conditions in which the US dollar weakens. Recent yield: 4.8%. Past bear market performance: –31% in 2007–2009. Recent share price: $84.01. (Philip Morris International was spun off from Altria—which sells Philip Morris brands in the US—as a separate company on March 28, 2008. From its inception date to the end of the 2007–2009 bear market, the stock fell 31%, compared with a decline of 48.5% for the S&P 500 over the same period.)

Union Pacific Corp. (UNP). This is the largest publicly traded railroad in North America, hauling cargo ranging from coal to agricultural products to automobiles through 23 states. The company has few direct competitors and an enduring cost advantage over every other form of shipping, especially on cross-country hauls, and it performs a vital service to hundreds of industries even in weak economies. The company produces more than $3 billion a year in free cash flow and has paid stock dividends for 116 consecutive years. Recent yield: 2%. Past bear market performance: –41.6% in 2007–2009…+34% in 2000–2002. Recent share price: $107.31.

*Performance for the bear markets covers January 4, 2000 to October 9, 2002 and October 9, 2007 to March 9, 2009.

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