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Now that stocks have fallen every week this year, the question has become: How do we prepare for the possibility that equities may continue to slide in February and even March?
In other words, how do we protect our portfolios?
It’s a good question for someone like me, who remains an unabashed bull even as the S&P 500 has dropped 3 percent this year. The answer is that I am constantly challenging my own assumptions — which is a great habit to get into — and I try to build in as much downside protection as possible with the use of three main tools:
- I use the Weiss Ratings Model results when picking individual stocks. Using a huge set of quantitative algorithms, the model looks not only at individual firms’ growth prospects, but also at how management handles debt, dividends and so forth. By sticking to the highest-rated stocks and moving out of those whose ratings fall, I give myself a strong starting point. Remember the financial crisis of 2008? The Weiss Ratings on the biggest losers in that debacle had begun to turn negative as early as January 2007, giving us plenty of warning we needed to eschew banks in our portfolios.
- I typically hold a sizeable position in cash as protection for when the whole market tumbles. In the extreme, like during the scary days in mid- to late 2011, I even added some short-market exposure with inverse ETFs (which go up when the market goes down). I do not advocate shorting individual stocks. However, broader-based ETFs can balance long holdings in your portfolio. And they do so in a diversified way.
- Diversification is the best way to stay long in the market. It’s overlooked by even the largest professional investors at times, but it’s the most important way to “stay in the game” even as markets drop for particular sectors, industries or stocks.
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| Consumer staples are always in demand, no matter how the economy is performing. |
I have been writing to you over the past several weeks about how I think — through my analysis of the Ratings Model data and my own fundamental work — that the market will, indeed, rise for 2014 as a whole. My working assumption (which, naturally, I challenge every day) is that the market should rise about 10 percent for the year. And that means a 3 percent decline so far is starting to make for some pretty good-looking purchase opportunities. But while I work to tilt my portfolio to pro-cyclicals, I want to make sure I do not lose sight of the importance of diversification.
Currently, my focus is on consumer-staples firms, and I’m starting with a deeper study of dozens of the highest-rated staples stocks. Three in particular, right at the top of the list of highest-rated (and so all are rated A+), I think could make for sound investments in their own right, and can provide diversification to your portfolio:
- CVS Caremark (CVS) is a household name. Over the years, the company has organized stores to be more profitable. But the firm is also in an enviable position with its ownership of Caremark, a pharmacy-benefits manager, which steers customers to the back of the store for medications, and has real profit potential all by itself.
- Hershey (HSY) is beloved for its chocolate. Although there is the threat of spiking cocoa prices eating into margins, company management is well-known for hedging those risks and running a tight ship. The stock could pull back in the near term, but I would use any downturns as buying opportunities. It would take a lot to sink this ship.
- For the more adventurous investor, I would recommend checking out Hormel (HRL). Here is a meat processor — the maker of Spam and Hormel Chili, no less — that has grown over the years by acquiring brands of goods that are stocked near the company’s traditional products in stores’ refrigerated and frozen sections. This is a well-run company whose management is focused on creating shareholder value.
I may, or may not, purchase any of these three, as my analysis continues on the highest few dozen firms in the Ratings Model. I’m keeping the three tickers on a Post-It note stuck to the corner of my computer screen. I’ll let you know more in subsequent columns.
Best,
Don Lucek
