3 Clues Pointing To A Market Drop And 5 Stocks For Protection

Includes: ABX, KO, LINEQ, NKE, TWO
by: Efficient Alpha

Friday's employment report could be a rude awakening for a market trying to balance strong investor sentiment and weak economic data. The market is expecting around 120,000 jobs to have been created in October but three clues over the past weeks suggest a surprise to the downside.

Unemployment, Durable Goods and Europe

The first clue came from the recently released report on September durable goods orders. The report was taken positively with a headline increase of 9.9% over the month before. What the market missed was the poor performance in non-defense capital goods ex-aircraft, a proxy for business investment, which was unchanged. Shipments for core durable goods fell 0.3% on the month and decreased the three-month average rate to -4.9% as well. Many economists have been predicting a drop in business investment for the fourth quarter due to fiscal cliff concerns, and this report seems to confirm those fears.

After performing well coming out of the recession, manufacturing has been especially weak in the last two jobs reports. The sector lost 38,000 jobs in September and August, wiping out the gains made in the previous three months. Government employment actually added to the report last month but may be weaker in the coming months leading up to the fiscal cliff. The biggest clue to a disappointing jobs report comes from the initial claims data released on the 18th of October. The original report of 388,000 was revised up to 392,000 new claims for the week. The report was especially important because it was the survey week for the month's employment report. The last time we saw a claims report this high was in June, which saw an employment report with just 45,000 new jobs created in the month.

The final strike to the tenuous upward momentum in the markets may be from a renewed bout of problems in Europe. Greece is expecting a $40 billion aid payment in November but Euro-area governments have been pressing the country to go further on spending cuts. The Greeks, now entering their sixth year of recession, have fought back against some of the demands. The country has $6.5 billion in debt coming due on November 16th and may run into trouble if a compromise cannot be reached.

Low Beta Names with Strong Dividends and High Return on Equity

Three fundamentals usually top my list of screening options when it comes to portfolio protection: a beta below that of the market, a high return on equity and a reasonable dividend yield. A lower beta, a measure of volatility relative to the market, means the shares may not fall as much as other stocks. A high return on equity means management is able to use investor equity effectively and dividend paying stocks have received a lot of interest in the last couple of years against record low bond rates.

Coca Cola (NYSE:KO) trades with a beta of just 0.41 and pays a 2.8% dividend yield. The company has a 27.4% return on equity, the highest among the five stocks. The shares are fairly defensive with sales of non-alcoholic beverages stable throughout the economic cycle. The company recently pledged $1 million to disaster relief efforts across the Northeast.

Barrick Gold (NYSE:ABX) trades with a beta of just 0.27 and pays a 2.0% dividend yield. The company's return on equity of 17.7% is above 92% of peers in the industry. The company reports third-quarter earnings on Thursday after a disappointing second quarter when the miner cut its production target in the face of large cost overruns. Analysts are expecting a positive report on higher gold prices and stabilizing expenses.

Two Harbors Investment (NYSE:TWO) trades with a beta of just 0.43 and pays a 12.3% dividend yield. The company's return on equity is 14.1%, higher than 86% of peers in its industry. Mortgage REITs have come under pressure lately as the Fed's bond buying program threatens lower yield spreads and faster mortgage prepayments. Despite some impulse selling, the sector still benefits from a strengthening housing market and a strong credit environment.

Nike (NYSE:NKE) trades with a beta of just 0.79 and pays a 1.6% dividend yield. The company sports a 21.4% return on equity, the second highest of the group. The company recently announced that it would sell its Umbro unit to the Iconix Brand Group (NASDAQ:ICON) for $225 million in cash. The deal should close later this year and help Nike focus on divisions with higher growth and profitability.

Linn Energy (LINE) trades with a beta of just 0.86 and pays a 6.9% dividend yield. The company is an oil and natural gas producer focused on buying older fields with stable production. The trailing return on equity is 7.6%, lower than the other four names, but above average for its industry. Last month, the company raised $1.1 billion from the IPO of its LinnCo (LNCO) shares in a move to attract more institutional investors and pay down debt.

With the market on edge after the devastation and economic effects of Hurricane Sandy, an employment report under 100,000 may give bears control and send prices downward. The market dropped by 2.4% in the week following July's report of just 45,000 jobs created in June. Investors should look for safety in dividend payers with low betas and high return on equity.

Disclosure: I am long TWO, LINE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.