The news grows more and more ominous by the day. The economic news continues to disappoint. Global events are also disappointing. We can find unrest in Latin America, the Middle East and Africa. In Asia, there’s a threat of war. In North America and Europe, sluggish growth and political divides prevent action.
These conditions could be the setup for a bear market. And, many investors are worried about that. It’s not just the news that worries investors. Valuations are high and the technical condition of the market is generally overbought. We’ve seen bear markets begin after these conditions were in place before.
On the other hand, we have also seen markets ignore news, valuation and technical signals. It is possible the stock market could keep rising. It could become much more overvalued than anyone expects before falling. This presents a challenge to investors.
To manage risks, many investors will avoid committing new funds to the market. This does protect against the risk of a loss. But, it creates the risk of missing out on potential profits if the market continues moving up. Instead of avoiding all stocks, investors can consider investing in defensive stocks.
Defining Defensive Stocks
A defensive stock is generally defined as a stock that pays a dividend and can be expected to deliver earnings no matter what the economy does. The expectations of income and stable earnings means the stock can do well in bull or bear markets and provides a degree of defense against a bear market.
History shows that defensive stocks generally tend to be among the best performers in times of recession. This is because the stocks are in sectors that provide goods and services consumers need. It might be possible for them to reduce spending in a recession but it will be almost possible to avoid buying from these companies.
When considering defensive sectors, the utility industry is among the most commonly cited example of defensive stocks. This is simply because whether the economy is expanding or contracting, consumers and businesses will still need at least a minimum amount of electricity, natural gas and water.
Investors have long known this. Investors also have a tendency to make moves related to their portfolio in anticipation of changes. So, when they believe the economy is likely to contract or a bear market is possible, investors tend to sell growth stocks and buy stocks in defensive sectors.
In addition to utilities, companies that produce consumer staples are also considered to be defensive. Staples are the products that consumers buy because they need them. For example, cleaning products are staples and companies that make these products are considered to be defensive stocks.
Investors generally expect defensive stocks to be steady performers. According to one study, during the ten year period ending in June 2016, defensive stocks delivered a total return of 128.2%. This is almost double the 65.3% total return for the S & P 500 index.
In addition to delivering gains, defensive stocks are expected to provide protection against losses. That same study shows that during the twenty year period with that same end date, the worst three year performance of defensive stocks was a loss of 1% a year, on average. The S&P 500 lost an average of 16% a year over that time.
Finding Defensive Stocks
Given the heightened risk in the stock market, it makes sense for investors to consider defensive stocks. But, it also makes sense for investors to consider stocks with the potential to deliver gains along with protection and income.
To find stocks that have the potential to deliver significant gains, we focused on inexpensive stocks. In particular, we screened for stocks that were under $10 at the time we wrote this. Stocks trading at low prices can deliver large gains in percentage terms, even during bear markets if their fundamentals are sound.
We used the free stock screening tool at FinViz.com. We searched for stocks with a price below $10 and a dividend greater than 0 so that they provided some level of income. These criteria do not provide insights into the quality of the company or the safety of the income.
Finally, we completed multiple scans for companies based on sector. We reviewed all utility and consumer staples sectors. Our search identified just six stocks.
Companhia Energética de Minas Gerais (NYSE: CIG) is involved in the generation, transmission, distribution, and sale of electricity throughout Brazil. The company utilizes renewable energy sources, such as, water, sun, wind, and biomass; or non-renewable sources, including fossil and nuclear fuels to generate electricity. As of December 31, 2016, it operated hydroelectric plants, thermoelectric plants, and solar plants with a total installed capacity of approximately 8,000 megawatts in 10 states of Brazil. In addition, the company is involved in the telecommunications and energy solutions consulting businesses; exploitation of natural gas; sale and trading of electricity; and acquisition, transport, and distribution of gas and its subproducts and derivatives, as well as provision of technology systems and systems for operational management of public service concessions, including companies operating in electricity, gas, water and sewerage, and other utility companies.
Cosan Limited (NYSE: CZZ) engages in fuel and natural gas distribution, logistics, lubricant, sugar and ethanol, and fuel businesses. The company operates through various segments. The Raízen Energia segment produces and markets various products derived from sugar cane, including raw sugar, and anhydrous and hydrated ethanol. This segment is also involved in activities related to energy cogeneration from sugarcane bagasse; and holds interests in companies involved in research and development on new technology. Its Raízen Combustíveis segment distributes and markets fuels, primarily through a franchised network of service stations under the Shell brand in Brazil. The COMGÁS segment distributes piped natural gas to customers in the industrial, residential, commercial, automotive, thermogeneration, and cogeneration sectors in part of the State of Sao Paulo. Its Cosan Logística segment provides logistics services for transport, storage, and port loading of commodities, primarily for sugar products; and leasing or lending of locomotives, wagons, and other railway equipment. The company’s Lubricants segment produces and distributes lubricants under the Mobil brand and Comma name. The company operates around 6,000 Shell service stations and 960 convenience stores, as well as 67 distribution terminals and 64 airport terminals.
TerraForm Global, Inc. (Nasdaq: GLBL) owns and operates renewable energy power plants. The company primarily serves customers in utility, commercial, industrial, and governmental sectors. As of May 31, 2017, the company’s portfolio consisted of solar and wind power plants located in Brazil, China, India, Malaysia, South Africa, Thailand, and Uruguay with an aggregate net capacity of 919.0 megawatts.
TransAlta Corporation (NYSE: TAC) is a non-regulated electricity generation and energy marketing company in Canada, the United States, and Western Australia. The company operates through eight segments: Canadian Coal, U.S. Coal, Canadian Gas, Australian Gas, Wind and Solar, Hydro, Energy Marketing, and Corporate. The company has an aggregate net ownership interest of approximately 8,716 megawatts of generating capacity.
Pingtan Marine Enterprise Ltd. (Nasdaq: PME) engages in the ocean fishing business and serves various customers, including distributors, restaurant owners, and exporters in China. The company harvests a range of fish species, such as ribbon fish, Indian white shrimp, croaker fish, pomfret, Spanish mackerel, conger eel, squid, and red snapper with its owned and licensed vessels operating within the Indian Exclusive Economic Zone, Indo-Pacific waters, the Arafura Sea of Indonesia, and international waters of the Atlantic and Pacific Oceans. As of December 31, 2016, it owns 91 trawlers, 15 drifters, 3 light luring seine vessels, and 2 squid jigging vessels, as well as had operating license rights to 20 drifters.
Crown Crafts, Inc. (Nasdaq: CRWS) operates in the infant and toddler segment of the consumer products industry through its fully owned subsidiaries. Crown Crafts Infant Products, Inc., designs, markets and distributes bedding, blankets, and other nursery accessories; and Hamco, Inc., designs, markets and distributes bibs, bath items and other accessories. Sales are conducted through retailers such as mass merchants, large chain stores, specialty stores, Internet retailers, wholesale clubs, grocery, and drug stores, as well as catalog retailers.
Any of those stocks is a potential investment candidate. Several of them could be bought to provide diversification. When there is a bear market, using history as a guide, defensive stocks could be winners or could at least be the smallest losers. Preserving capital could position investors to maximize gains in the bull market that will inevitably follow the bear.