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Is the stock market out of control? It's a fair question to ask when you see automated trading programs dump gazillions of shares at the end of the day and clip 2% off the value of troubled and thriving companies alike. Consider that between July 19, when the Dow Jones industrials closed at a then-record 14,000, and mid September, the Dow lost 200 or more points on eight different days and gained 200 or better four times.
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Although unremarkable in percentage terms, frequent moves of this magnitude are, not surprisingly, leaving investors uneasy. Throw in a barrage of negative headlines -- the subprime-mortgage mess, falling housing prices, a credit crunch, a spike in foreclosures, weakening employment and growing fears of a recession -- and it's no wonder that many investors are focusing less on making a killing and more on avoiding a slaughter.
The obvious move for pessimists and the faint of heart is to sell some stocks and move the proceeds to cash or bonds. But we don't recommend that course unless you'll need money soon for a particular goal or project (for editor in chief Knight Kiplinger's take on market timing, see Market Timing the Right Way). Don't forget that the stock market's long-term trend is up.
A better tack is to seek shelter in stocks that are best suited to weather a market storm -- whether it's a mere thundershower or a cataclysmic hurricane. With a number of pundits suggesting that the U.S. may experience a recession within the next year, you should focus on low- to moderate-risk, high-quality businesses that can survive and perhaps even thrive in a deteriorating economy. It also helps to look for stocks, such as AT&T and American Express, that historically have shown they can quickly rebound from massive, marketwide selloffs.
Keeping these factors in mind, we present you with five strategies for identifying stocks that will keep you out of trouble during stormy markets. Plus, see Four Low-Risk Mutual Funds for our picks that are built to avoid catastrophic losses but that are capable of rewarding shareholders over the long term.
Low risks, good gains
Finding a stock that beats the market but does so with less risk is as close as you'll come to nirvana in the investing world. For statistics geeks, the intersection of safety and good performance means a stock has a high alpha and a low beta. Alpha measures the amount by which an investment's return exceeds the yield of risk-free Treasury bills. Beta compares a stock's movements with that of a benchmark -- for domestic stocks, typically Standard & Poor's 500-stock index. Stocks with high alphas and low betas usually earn high grades from the Value Line Investment Survey for "price stability" and "earnings predictability," hallmarks of low-risk investments.
Look back five years and this exercise turns up a bunch of energy and technology stocks. Both sectors remain attractive, despite reputations for being unpredictable and closely connected to the overall health of the economy. Looking back over the past three years, you find more health, food and service companies to go with the energy and tech stocks. What you won't find are retailers, financial companies (other than some insurers), housing and real estate companies, media and publishing firms, automakers, and plain old laggards of scant interest in any kind of market. The performance of these previously low-risk, high-performance stocks since the market's July peak has been mixed.
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