5/10/2011 1:09 PM ET
Wall Street is getting ready for a pullback, and so should you. Here are strategies to help you get defensive, protect your portfolio and save your nest egg.
Related topics: stocks, stock market, ETF, shorting, Anthony Mirhaydari
Wall Street is preparing for a downturn.
And that means it's time for everyday investors to move away from the assets and strategies that have performed so well over the last two years, as the Standard & Poor's 500 Index ($INX) has risen by roughly 50%.
Professional traders have quietly been taking their chips off the table for the past few months -- the type of shift seen in the final stages of a bull market.
Instead of looking for ways to maximize gains, most investors should focus now on minimizing losses. In this column, I'll give you three ways to play defense in this environment, from the staid and cautious to the fairly adventurous.
What are defensive stocks?
First, here's a quick look at why this shift is happening:
The shift started slowly. Back in late February, the smallest and riskiest stocks in the market -- those most sensitive to the economy's ups and downs -- started to underperform. New leaders emerged in defensive sectors like health care and consumer staples. In April, the health-care stocks in the S&P 500 gained 6.5%, while staples stocks gained 5.2%. Energy stocks added only 1.5%, while basic materials climbed just 2.2%.
Anthony Mirhaydari
As this was playing out, people became infatuated with huge rises in commodities like silver and crude oil. Speculation ran wild. At the same time, the normally more stable industrial commodities like copper and lumber began to move lower. Something wasn't right.
The driver was the fact that the economic situation was deteriorating. Food-and-fuel inflation was spreading through the system like a cancer. Consumer confidence was waning. Europe was still fighting its debt crisis. Emerging markets were jacking interest rates higher to fight inflation. And a supportive monetary and fiscal policy was set to end here at home.
The budget fight in Washington was becoming white hot, while state and local governments were forced to embrace painful austerity measures. The Fed fitfully acknowledged that the risk of inflation was becoming too hard to ignore -- effectively tabling any plans for further injections of money into the economy.
/*
Last week the situation really began to unravel -- just days after I had pleaded on April 27 for investors to "run and hide" on a "constellation of concerns."
A number of factors had combined to shake people out of their complacency and the false belief that more cheap cash from the Federal Reserve could solve all our problems.
When everyone was excited about rising profits at exporters like Caterpillar (CAT, news), it was easy to forget that more than 70% of the economy still depends on consumer spending. But we got reminders in the terrible advance estimate of first-quarter gross domestic product growth figures, and in very weak April economic reports.
This realization, combined with a big jump in the dollar on May 1 -- after President Barack Obama restored some faith in American prowess by announcing we had killed Osama bin Laden in a daring raid -- began to unwind things. On May 2, silver crashed. On May 3, it was energy stocks. On May 4, it was emerging-market stocks. On May 5, it was copper and crude oil. On May 6, it was the euro and European stocks. Silver ended last week down 27%.
All this is like watching a train derailing in slow motion. Investors need to take action to avoid becoming casualties. Here are three strategies for protecting yourself:
1. Get safeIn my April 27 column, I provided some simple, usable advice to investors looking for more protection. This included a broad recommendation to move away from cyclical, or economically sensitive, sectors like energy, materials and technology in favor of less sensitive stocks in the sectors of health care, consumer staples and utilities.
These recommendations still stand -- although in a perfect world I would recommend avoiding stocks altogether right now, because defensive favorites like Merck (MRK, news), Johnson & Johnson (JNJ, news) and Kraft Foods (KFT, news) have already started moving up. That's the trouble with defensive stocks: They tend to outperform for a short time as the stock market forms its top just before a downturn. Then, health care and staples and other noncyclicals tumble lower along with all the other issues -- they just don't fall as much.
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A number of factors had combined to shake people out of their complacency and the false belief that more cheap cash from the Federal Reserve could solve all our problems.
When everyone was excited about rising profits at exporters like Caterpillar (CAT, news), it was easy to forget that more than 70% of the economy still depends on consumer spending. But we got reminders in the terrible advance estimate of first-quarter gross domestic product growth figures, and in very weak April economic reports.
This realization, combined with a big jump in the dollar on May 1 -- after President Barack Obama restored some faith in American prowess by announcing we had killed Osama bin Laden in a daring raid -- began to unwind things. On May 2, silver crashed. On May 3, it was energy stocks. On May 4, it was emerging-market stocks. On May 5, it was copper and crude oil. On May 6, it was the euro and European stocks. Silver ended last week down 27%.
All this is like watching a train derailing in slow motion. Investors need to take action to avoid becoming casualties. Here are three strategies for protecting yourself:
In my April 27 column, I provided some simple, usable advice to investors looking for more protection. This included a broad recommendation to move away from cyclical, or economically sensitive, sectors like energy, materials and technology in favor of less sensitive stocks in the sectors of health care, consumer staples and utilities.
These recommendations still stand -- although in a perfect world I would recommend avoiding stocks altogether right now, because defensive favorites like Merck (MRK, news), Johnson & Johnson (JNJ, news) and Kraft Foods (KFT, news) have already started moving up. That's the trouble with defensive stocks: They tend to outperform for a short time as the stock market forms its top just before a downturn. Then, health care and staples and other noncyclicals tumble lower along with all the other issues -- they just don't fall as much.
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Quotes are real-time for NASDAQ, NYSE and AMEX. See delay times for other exchanges.
Fundamental company data and historical chart data provided by Thomson Reuters (click for restrictions). Real-time quotes provided by BATS Exchange. Real-time index quotes and delayed quotes supplied by Interactive Data Real-Time Services. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Gradient Analytics. IPO data provided by Hoover's Inc. Index membership data provided by SIX Telekurs.
Japanese stock price data provided by Nomura Research Institute Ltd.; quotes delayed 20 minutes. Canadian fund data provided by CANNEX Financial Exchanges Ltd.
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