In recent years, the phrase "seeking alpha" has come into vogue. This refers to the ability of a portfolio to outperform the broader market or a related set of benchmarks. Yet in light of the market's choppy start to the second quarter, it may be better to seek "beta."
What's beta? It's the measurement of how a stock tends to react to the broader market. A stock with a high beta -- say, of 2.0 -- means it will typically move up or down at twice the rate of the broader market. (You can find this figure on the StreetAuthority's Yaho o Finance page. Just enter in a stock symbol and click its "key statistics" page.)
Low Beta = Defense
Low-beta stocks are often referred to as "defensive stocks." These aren't stocks that operate in the defense industry -- they're stocks (and sectors) that tend to hold their own in any market environment.
Take electric utilities, for example. Both Consolidated Edison (NYSE: ED) and Southern Co. (NYSE: SO), which are among the largest power providers in the eastern United States, each have a beta of less than 0.25. For that matter, other utilities such as Northwest Natural Gas Co. (NYSE: NWN), PG&E (NYSE: PCG) and WGL Holdings (NYSE: WGL) have very low betas.
Of course, such a low beta means that these kinds of stocks may not move very quickly when high-growth tech stocks are zooming ahead. Instead, investors often like them for their steady and growing dividends. And with such low betas, a 20% drop in the stock market would typically entail less than a 5% drop for these stocks.
Companies in the food business are also often seen as low-beta plays. Regardless of the broader economic climate, people still need to eat. As a result, sales and profits for these companies tend to be quite stable.
General Mills (NYSE: GIS), which owns dozens of brands such as Betty Crocker, Haagen-Dazs and Yoplait, is a model of consistency. Every year, management hikes the dividend (at a 10% annual pace over the past five years), and the company's base of investors tends to simply buy and hold this stock. As a result, its beta is quite low. Yet even a seemingly defensive stock is capable of solid share price appreciation.
If you are looking for fresh stocks in this extended bull market but are leery of getting in as the party is ending, then be sure to check out the beta. It's a good practice to know the beta of all of your portfolio holdings, as the highest-beta stocks may make the best sell candidates when it comes time to raise cash.
For some investors, it's crucial to hedge against a falling market by owning stocks or funds that tend to move in the opposite direction of the stock market. These are known as "negative beta" investments. You won't find any stocks that have a negative beta, as they would eventually fall to zero as the stock market tends to rise over the course of many years.But there are a number of exchange-traded funds (ETFs) that do the job. These are known as inverse funds, as they move in the opposite direction of the market. The most popular negative-beta inverse funds include:
- ProShares UltraShort S&P500 ETF (NYSE: SDS): This ETF moves at twice the rate of the S&P 500 in the opposite direction.
- Direxion Daily Small Cap Bear 3X Shares (NYSE: TZA): This ETF moves at three times the rate of the small-cap focused Russell 2000 in the opposite direction.
- ProShares Short QQQ (NYSE: PSQ): This fund moves in the opposite direction -- on a 1-to-1 basis -- as the Nasdaq 100.
Risks To Consider: A focus on low-beta stocks could lead to an underperforming portfolio if the market moves yet higher. A focus on negative-beta investments could cause you to lose money when the markets rise.
Action To Take --> The S&P 500 has already managed to fall more than 1% on two separate occasions since the beginning of April. Those drops may be a sign that the long-standing bull market is getting tired. A sideways market is often a harbinger of an eventual shift in market direction, which is why it's important to take a defensive posture when you're aiming for further upside. As this chart shows, the S&P 500 is just above its 50-day moving average, and any move below 1,540 may signal trouble ahead.