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Refuge from Volatility in Apple, Chipotle

Investors flustered by the widest swings in the Standard & Poor’s 500 Index in two years may find refuge from the volatility in Apple Inc. (AAPL), Chipotle Mexican Grill Inc. (CMG) and Ross Stores Inc. (ROST)

The companies were among 118 in the S&P 500 with positive risk-adjusted returns in the six-month, 12-month, and three- and five-year periods ended last week, according to a Bloomberg data study. Six of the top 10 companies, including AutoZone Inc. (AZO) and McDonald’s Corp. (MCD), are tied to the consumer.

A European debt crisis, concern that the U.S. economy may slip back into recession and U.S. politicians’ squabbling over the deficit caused the S&P 500 to move more than 2 percent on 19 trading days last quarter, compared with 1 day the previous quarter. The Chicago Board Options Exchange Volatility Index rose to the highest average during the quarter in two years.

“The extreme volatility is creating a lot of nervousness and hand-wringing,” said Philip Orlando, chief equity market strategist at Federated Investors Inc. in New York, which manages about $350 billion. “Our allocations across the shop are more cautious and more conservative and more neutral today than they were three or four months ago.”

Burrito chain Chipotle, which jumped sixfold in the past five years with few dips along the way, had the highest risk- adjusted return ranking among the companies studied. Amazon.com Inc. (AMZN) ranked second, with Goodrich Corp. (GR), AutoZone and Ross trailing. McDonald’s was sixth, then Watson Pharmaceuticals Inc. (WPI), Consolidated Edison Inc. (ED), Apple and EQT Corp. (EQT)

Places to Hide

“There is a payoff for holding low-volatility issues,” said Richard Weiss, a senior portfolio manager at American Century Investment in Mountain View, California. “It is a viable strategy proven out in the research.”

Federated, which has boosted its cash position to about 5 percent from a typical level near zero, uses computer models to uncover “good places to hide out,” Orlando said. The models mostly embrace staples and health care, while showing utilities and telecommunications services poised to fall, he said.

Orlando cited Coca-Cola Co. (KO), Procter & Gamble Co. (PG) and Colgate-Palmolive Co. (CL), which may have the potential to rise to the top of the pack for risk-adjusted returns. New York-based Colgate ranks 24th in the Bloomberg analysis of most return for the least volatility over five years. Atlanta-based Coca-Cola was 80th and Cincinnati-based P&G came in 83rd.

“Their valuation has held up better because of the sustainability of their revenue and earnings stream in a challenging economic environment,” Orlando said.

Falling Stars

The five-year Bloomberg analysis divides the share gain by the average swing in price and only ranks companies that had positive risk-adjusted returns for each of the four periods studied: six-month, 12-month, and three- and five-years.

Among the stocks that topped the list, at least two, Apple and Amazon, may see a fall in rank. Amazon, the world’s largest Internet retailer, plunged yesterday the most since 2008 after missing profit estimates by 42 percent -- the biggest negative surprise of any technology business in the S&P 500. Apple, the biggest smartphone maker, also dropped the most in almost three years on Oct. 19 after profit fell short of predictions.

Apple’s results have investors divided about whether the Cupertino, California-based company will remain a haven.

“Apple’s probably going to underperform for the next few months just based on the earnings that came out,” said Michael Gibbs, chief equity strategist for Memphis, Tennessee-based Morgan Keegan & Co., which manages $70 billion.

The stock jumped almost fivefold over five years. Orlando said Apple can still rely on its brand momentum with the iPhone and iPad and should continue to outperform on sales and profit.

Amazon’s Gamble

“If you look at the quarter, it seemed to be more a timing problem on the phones rather than anything more serious,” Orlando said.

Amazon is being tripped up by Chief Executive Officer Jeff Bezos’s effort to take on Apple in the market for tablet computers. Amazon’s spending on new products contributed to a 73 percent decline in third-quarter net income, and a strategy of pricing the new Kindle Fire tablet at a loss of about $10 each, according to research firm IHS Inc., may hurt the Seattle-based company’s profit margins.

“We’ve got some changes in the business model that are really going to hurt profitability,” said Colin Gillis, a New York-based analyst with BGC Partners LP who recommends selling Amazon stock. “This name is priced at a premium and earnings continue to disappoint.”

Utilities, Technology

Amazon should be priced in line with a discount retailer, he said. Instead, it’s trading at multiples much higher than Apple, which has bigger profit margins and is growing faster. Amazon’s price to earnings ratio has surpassed 100, while Apple’s is hovering at about 14, according to Bloomberg data.

American Century recently moved to neutral on growth stocks including technology and industrial companies “to take profits” after those areas outperformed, Weiss said.

Weiss said he’s contemplating going overweight on defensive industries such as utilities because of the lack of clarity on the direction of the economy. Such a move would be coupled with investment in a growth industry, such as technology, he said.

Investors have already started to pile into utilities and health-care stocks. The S&P 500 Health Care Index rose 5.9 percent this year as of yesterday, while the S&P 500 Utilities Index (S5UTIL) jumped 10 percent. That compares with a 1.2 percent drop in the broader S&P 500.

Seeking Stability

Seeking stability in today’s market may backfire, said Gibbs of Morgan Keegan. Stocks are undervalued and will probably take off once the European Union comes up with a solution to its sovereign debt crisis, he said.

Energy and industrial companies stand to gain the most once confidence in the economy returns, Gibbs said.

“If you’re buying utilities now because they’re performing better and less volatile and you’re buying some health-care names for the same reason, prepare yourself to underperform if you get a market that turns and runs,” he said.

The riskiest strategy for overcoming market swings is trying to time them, Weiss said. Eliminating risk by sitting on cash also isn’t viable with current Treasuries yields, he said. Instead, many investors are hedging against volatility as part of their portfolio, Weiss said.

Exchange-traded notes can be bought to hedge against drops in oil, gold, the euro and in indexes such as the German DAX and London FTSE, Weiss said. American Century is looking to introduce new funds next year to help clients buy “insurance” against large drops in the market, Weiss said.

“You can make volatility your friend,” Weiss said.

Playing It Safe

Wide swings in stock prices are here to stay as the world’s financial systems become more intertwined and as U.S. companies expand more to emerging markets in search of higher profits, said Yuhang Xing, a professor of empirical asset pricing at Rice University in Houston.

“Twenty years ago, why would investors in the U.S. care about a Greek default, why would they care about something happening in China?” Xing said. “The systemic risk is more concentrated.”

In a research paper that Xing helped write, data showed that stocks with high volatility gave lower returns. One of the main reasons is that with the sharp movements, it was difficult to short the stocks to take advantage of declines, Xing said.

“If you have higher volatility, you’re supposed to get compensated for taking on more risk,” Xing said. “But it’s the opposite in the data.”

With clouds hanging over Europe and the U.S. economy, it’s difficult to play it safe in a market that’s going to keep bouncing around, Orlando of Federated said.

“No one is sleeping well at night,” he said.

To contact the reporter on this story: Thomas Black in Monterrey at tblack@bloomberg.net

To contact the editors responsible for this story: Ed Dufner at edufner@bloomberg.net; Kevin Miller at kmiller@bloomberg.net

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