With the Dow Jones Industrial Average reaching a new all-time high for the first time since the Great Recession and financial crisis, and the S&P 500 creeping closer and closer to its record high, many investors have been getting worried that the stock market is overheated. Headlines like "Skepticism High Amid Market's Rally", and "When Will This Big Pullback Finally Happen" have been prominent in most financial publications and websites for weeks now, only adding to the sense that are due for a downturn.
I, for one, am not so sure. Valuation measures on the whole continue to paint a picture of a market that is trading somewhere in the range of fair value. The housing market continues to rebound. And the Federal Reserve continues to push investors toward risk assets. All of those factors are bullish for stocks.
Regardless of whether a correction is coming, however, I'm not one to try to time the market -- and you shouldn't be either. Far too many investors, succumbing to their own emotions and behavioral biases, end up buying high and selling low when they try to jump in and out of market. In his recently released annual letter to Berkshire Hathaway shareholders, Warren Buffett noted that stocks gained more than 17,000% in the 20th century -- despite wars, depressions, and a host of other issues. "Since the basic game is so favorable," he said, "Charlie [Munger, his Berkshire partner] and I believe it's a terrible mistake to try to dance in and out of [the market] based upon the turn of tarot cards, the predictions of 'experts,' or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it."
If your emotions are getting the better of you amid all this pullback talk, and you really feel like you need some downside protection, you might want to consider some defensively-oriented stocks. Stocks in sectors like healthcare and utilities often are steadier performers than the broader market, and don't get hit as hard as other stocks when times get tough. By looking to stocks like these, you stack the odds in your favor that you will limit losses if the market does pull back (though, of course, it's not a guarantee), but keep yourself exposed to stocks in the event that you're wrong and stocks keep heading higher (and, if you're like most investors, there's a good chance you will be wrong).
Recently, I used my Guru Strategies (each of which is based on the approach of a different investing great) to find some of the most fundamentally sound stocks in defensive areas of the market. Here's a sampling of what I found:
Merck & Co. Inc. (MRK): This healthcare giant ($132 billion market cap) offers an array of prescription medicines, vaccines, biologic therapies, and consumer care and animal health products, operating in more than 140 countries. It's a favorite of my James O'Shaughnessy-based value model. When looking for value plays, O'Shaughnessy targeted large firms with strong cash flows and high dividend yields. Merck is plenty big enough, and it also has $4.55 in cash flow per share (more than three times the market mean), and a 3.9% yield, all of which help it pass the O'Shaughnessy-based model.
Newmont Mining Corp. (NEM): When investors get fearful, they turn to gold, which is why gold fared so well from 2007-2011 -- and why it's struggled in the past year-plus, as investors have gotten more risk tolerant. It thus makes sense, if you're worried about the market and economy, to have a gold miner like this Colorado-based firm in your portfolio. My Peter Lynch-based model likes its 16% long-term growth rate (using the average of the three- and four-year earnings per share growth rates) and 10.3 P/E ratio, as well as its 4.4% dividend yield. Lynch famously used the P/E-to-Growth ratio to find bargain-priced stocks, adjusting the growth part of the equation for dividend yield with firms like Newmont. Newmont's yield-adjusted PEG is 0.5, which comes in well below the model's 1.0 upper limit, a great sign.
Medtronic, Inc. (MDT): Minnesota-based Medtronic ($47 billion market cap) is the world's largest independent medical technology company, making a wide array of products that alleviate pain, extend life, and restore health. It gets high marks from my Lynch-based model, which likes its 13.6% long-term growth rate (using an average of the three-, four-, and five-year EPS growth rates), 14.1 P/E, and 2.2% dividend, which make for a 0.89 yield-adjusted PEG.
Accenture PLC (ACN): Ireland-based Accenture provides management consulting, technology, and outsourcing services. Such a firm might not seem particularly defensive, but Accenture's broad global reach diversifies its risk quite a bit -- back in 2008 and 2009, when the U.S. and other developed economies were tanking, Accenture increased earnings per share.
Accenture ($54 billion market cap) is a favorite of my Warren Buffett-based model. It looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Accenture delivers on all fronts. Its EPS have dipped in only one year of the past decade; it has no long-term debt; and its 10-year average ROE is an impressive 48%.
Alliant Energy Corporation (LNT): This Wisconsin-based, investor-owned public utility serves about one million electric customers and about 414,000 natural gas customers in the Midwest. It has a $5.3 billion market cap.
My Lynch-based model likes Alliant. The firm has a long-term growth rate of just over 14%, a 16.5 P/E, and a 3.9% dividend yield. That makes for a yield-adjusted PEG of 0.92, a sign its shares are a bargain.