Going Long During The Fiscal Cliff Possibility

by: Jim Fish

The one thing dictating the market currently is: The Fiscal Cliff. The Fiscal Cliff is an investor's nightmare in the sense of the whip-saws in the market and the potential stock market falloff. One minute the S&P 500 is down 70 bps, and then a few hours later it is up 70 bps (just like what happened on November 28, 2012). How should equity investors position themselves for this rough ride and the potential falloff? All one has to do is incorporate the last 5 years' price movements and see the opportunity.

The graph below shows the returns of all the major indexes of the S&P 500 (AMEX: SPY, Source: Capital IQ). The three leaders based on return alone were Healthcare, Consumer Staples, and Consumer Discretionary. The three laggards were Materials, Energy, and Technology. The S&P 500 advanced 6.08% over the last 5 years (11/28/2007 through 11/28/2012):

Basing off of pure returns is not enough though. A risk-adjustment must be made so that investors can understand what they are getting into. A common risk-adjusted ratio is the Sharpe Ratio. The Sharpe ratio takes the return of the security or index, subtracts the risk free rate, and divides by the standard deviation of the security or index. The Treynor ratio does the same thing but uses beta over the standard deviation. The risk-free rate used was 5-year average of the 10-Year US Treasury, so as to match the time-frame (Source: Capital IQ):

By using the 2.97% risk-free rate, one can incorporate it into a risk-adjusted return metric. The table below shows the 5 year returns for each sector and the S&P 500 and the standard deviations of the returns for each sector (Source: Capital IQ and author):

Even on a risk-adjusted basis, the rankings do not change, as the same three leaders and laggards are in the same order. Taking this into account, one would invest in Healthcare. However, the graph below shows that it may not be the ideal time given the technical moving averages:

The index is trading between its 50 and 100 day moving averages. To a technician, this is not ideal timing to be buying into healthcare. Usually the ideal time is a bounce off of the 200 day moving average. Healthcare appears to have support at the former resistance of ~450, or the support line from this past August.

The next candidate is the Consumer Staples sector. The graph below shows that this is an ideal time to invest in Consumer Staples (Source: Capital IQ):

The reason I have both the Consumer Staples Index (red-line) and the Consumer Staples sub-group, Food, Beverage, & Tobacco, is because of the strength of the sub-sector. After analyzing and watching this sub-sector for a few years now, the sub-sector has performed extremely well. It has outpaced its parent index by almost 10%. This does not even include the dividend adjusted indices which the sub-sector pays out an above-average rate. Given that these two indices are trading close to their respective 200 day moving averages, this looks like an opportune time to put your money to work in this sector.

The only time in the last 5 years it broke this trend was The Great Recession. The indices fell but not as far as the other indexes in the S&P 500 due to the defensive nature and consistent demand by consumers. Consumers need to eat and buy everyday kind of goods. Notice how when the Consumer Staples and sub-sector indices traded below the 200 day moving average, it only lasted about 6 months

Below is a table of companies to consider investing in from the Food, Beverage, and Tobacco sub-sector. Some of them have had great 12 month price movements and thus great returns (Source: Capital IQ):

*MDLZ price decline amount is based off of where KRFT was trading and done by Capital IQ, not the author*

Another way to play this strategy is with the Vanguard ETF (AMEX: VDC), Powershares (AMEX: PBJ), SPDR (AMEX: XLP), or iShares (AMEX: IYK). Consumers will always need to eat. By picking up companies that are in demand and growing, such as Brown-Foreman (NYSE: BF.B), ConAgra Foods (NYSE: CAG), Constellation Brands, the importer of Corona, (NYSE: STZ), H.J Heinz (NYSE: HNZ), McCormick Inc (NYSE: MKC), Monster Beverage (NYSE: MNST), Phillip Morris (NYSE: PM), Coca-Cola (NYSE: KO), Hershey Co (NYSE: HSY), and J.M Smucker (NYSE: SJM), investors can potentially realize returns that are stronger than the overall market and not as risky. There are other names out there not on this list that investors could consider, such as General Mills (NYSE: GIS) or B&G Foods (NYSE: BGS).

What investors should takeaway from this article is that this sector provides a nice backbone to any portfolio, especially during turbulent times. The Consumer Staples sector was the one sector that really stood out in Q3 earnings announcements for not lowering guidance or missing estimates. Management at these firms are experienced and typically conservative. This all bodes well for investors in this sector and specifically in the Food, Beverage, and Tobacco sub-sector.

Disclosure: I am long MKC, HNZ. 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.