Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Stock Market Pause Should Extend - 21st April 19
Why Gold Has Been the Second Best Asset Class for the Last 20 Years - 21st April 19
Could Taxing the Rich Solve Income Inequality? - 21st April 19
Stock Market Euphoria Stunts Gold - 20th April 19
Is Political Partisanship Killing America? - 20th April 19
Trump - They Were All Lying - 20th April 19
The Global Economy Looks Disturbingly Like Japan Before Its “Lost Decade” - 19th April 19
Growing Bird of Paradise Strelitzia Plants, Pruning and Flower Guide Over 4 Years - 19th April 19
S&P 500’s Downward Reversal or Just Profit-Taking Action? - 18th April 19
US Stock Markets Setting Up For Increased Volatility - 18th April 19
Intel Corporation (INTC) Bullish Structure Favors More Upside - 18th April 19
Low New Zealand Inflation Rate Increases Chance of a Rate Cut - 18th April 19
Online Grocery Shopping Will Go Mainstream as Soon as This Year - 17th April 19
America Dancing On The Crumbling Precipice - 17th April 19
Watch The Financial Sector For The Next Stock Market Topping Pattern - 17th April 19
How Central Bank Gold Buying is Undermining the US Dollar - 17th April 19
Income-Generating Business - 17th April 19
INSOMNIA 64 Birmingham NEC Car Parking Info - 17th April 19
Trump May Regret His Fed Takeover Attempt - 16th April 19
Downside Risk in Gold & Gold Stocks - 16th April 19
Stock Market Melt-Up or Roll Over?…A Look At Two Scenarios - 16th April 19
Is the Stock Market Making a Head and Shoulders Topping Pattern? - 16th April 19
Will Powell’s Dovish Turn Support Gold? - 15th April 19
If History Is Any Indication, Stocks Should Rally Until the Fall of 2020 - 15th April 19
Stocks Get Closer to Last Year’s Record High - 15th April 19
Oil Price May Be Setup For A Move Back to $50 - 15th April 19
Stock Market Ready For A Pause! - 15th April 19
Shopping for Bargain Souvenirs in Fethiye Tuesday Market - Turkey Holidays 2019 - 15th April 19
From US-Sino Talks to New Trade Wars, Weakening Global Economic Prospects - 14th April 19
Stock Market Indexes Race For The New All-Time High - 14th April 19
Why Gold Price Will “Just Explode… in the Blink of an Eye” - 14th April 19

Market Oracle FREE Newsletter

Top 10 AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

When the Offense Changes, the Defense Needs to Adapt

Stock-Markets / Investing 2013 Oct 08, 2013 - 05:58 PM GMT

By: Don_Miller

Stock-Markets

When it comes to just about any sport, you don’t blindly use a strategy without considering your opponent’s next move, his strengths, and his weaknesses. To win, you have to adapt.

While the investment world can seem like the same old game with the same old rules, it’s always changing around the edges. If you don’t adapt, you won’t win this game either. With the ten-year US Treasury recently closing as high as 2.98%, we face new threats, and the definition of a good defensive stock has changed accordingly. Now they must be defensive and immune to higher rates.


High-yielding stocks are often the most interest-rate sensitive, which makes the game even more challenging for retirees. So, how do you stay defensive while still receiving yield? I turned to our crackerjack team of analysts for some answers.

Let’s start with where defensive stocks stood prior to the rapid rate increase. With yields near record lows, investors piled in to dividend stocks in search of income. But they didn’t pick just any stocks. With 2008 still fresh in investors’ minds, they specifically chose defensive stocks with a beta of less than 1. For a quick review, a beta of one means a 10% move in the stock market should theoretically move the stock 10%. A beta of 0.5 means a 10% move in the market should move the stock only 5%.

But it wasn’t just retail investors choosing defensive stocks with a beta of less than 1. More sophisticated analysts suggested moving into these stocks as well. One of the most common Wall Street valuation models examines three primary factors: dividends; beta; and the US Treasury rate. When the beta and Treasury rates are low and the dividend is high, a stock is considered to be more valuable. This model worked quite well. In fact, a number of stocks in the Money Forever portfolio that are well in the green were partially evaluated this way.

When Treasury rates rose, every stock evaluated by that Wall Street model was necessarily worth less. When risk-free Treasury yields are a little higher, risk in the market for yield necessarily looks worse. With that said, some dividend stocks were hit much harder than others. In particular, utilities and REITs took the biggest dives, but they weren’t the only ones. Even our dividend stocks were a bit shaken up, but not nearly as bad as some others.

Why did some dividend stocks get hit while others stayed afloat? It goes back to that Wall Street valuation model. Some of our stocks were partially evaluated using the same approach. The very key word here is “partially.” We had other great reasons for investing in them. The beta and dividends were nice, but they weren’t the only worthwhile qualities. Our Five-Point Balancing Test is a big reason for this difference. We were specifically searching for stocks with some appreciation potential.

In contrast, utility stocks don’t fit that bill. Their main purpose was a safe dividend. For many years, utility stocks were referred to as “widow’s stocks.” They were a safe investment with a decent yield. Many investment counselors put a lot of their clients’ money into these types of investments. Because they were considered safe, those counselors were unlikely to be accused of mismanagement.

When interest rates tumbled, many additional billions of dollars were poured into utility stocks, and their prices rose. In a sense, they began to act like bonds. And since rising interest rates hurt bond prices, the same was true for dividend stocks. The most defensive companies with the least growth and the highest dividends were the hardest hit. While many investors felt safe because their money was invested in solid companies, they were not protected from interest-rate risk.

Unfortunately, that was common wisdom for lots of investors: find the biggest yield and the most defensive stock. There are two solutions to this problem:

  1. Find stocks where the growth outweighs the interest-rate sensitivity. If a stock’s primary value driver isn’t the dividend, it will be less affected by rising rates. Similarly, if a company has good growth prospects and a high dividend, it will be minimally affected.
  1. Find defensive stocks without a large dividend. As investors sought yield, they piled into defensive, high-yielding stocks. If an investor just wanted a defensive stock, he often found himself piled on the same heap as the yield-seekers. One way to avoid the problem of rate sensitivity and overvalued defensive yield stocks is to search for places where yield-seekers aren’t looking, i.e., defensive stocks with a small dividend. These stocks don’t necessarily have tiny dividends—just not enough to catch the eye of yield-starved investors.

However, note that there is a caveat to the first solution I just mentioned. You still need to concentrate on defensive industries. A company can have good dividends with growth and appreciation, but it might be a terrible investment in a downturn. The financial sector is a perfect example of this. The dividends are good and a strengthening economy can give the sector growth, but those dividends won’t pay off should another 2008 be just around the corner.

With that in mind, our team produced The Cash Book, a comprehensive guide that reveals how to protect your wealth in this new age of finance. It’s a handy guide filled with ideas you won’t hear about from your financial advisor, like how to legally get around the FDIC’s $250,000 cap on insurance, the 10 safest states to do your banking, and how the average person can open an account in Switzerland without attracting extra scrutiny from the IRS.

Normally The Cash Book is only available to Money Forever subscribers, but because it’s now more important than ever to diversify our retirement nest egg away from traditionally "safe" investments, we’ve made it available on its own. Get these easy-to-use strategies for protecting your wealth from the many threats facing us today: click here for your copy.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Casey Research Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules