Top Defensive Plays, Low-Beta Beauties

With equity markets wobbling, S&P thinks investors should move toward stocks with low volatility and high dividend yields

During the week of July 23, just a few days after the Dow Jones industrial average established an all-time high above the 14,000 level, U.S. equity markets declined and the Standard & Poor's 500-stock index slumped 4.9%. All 10 sectors in the "500" posted declines, and only two of its 130 subindustries advanced: Internet Retail (+11.0%) and Household Products (+1.1%).

At this point, S&P believes many investors are considering one of at least three options: 1. Raise cash—which S&P does not recommend, since we don't think this pullback is the beginning of a new bear market; 2. Stick with stocks, but gravitate toward more defensive issues; or 3. Be brave, and buy beaten-down issues. The subject of this week's Sector Watch is option No. 2. We'll wait to be brave next week.

So how does one define defensive issues? Two things stand out: beta, or the group's volatility vs. the S&P 500, and dividend yield, the amount one gets paid while waiting for share prices to recover. Within the S&P 500, the Consumer Staples, Health Care, Utilities, and Energy sectors had the lowest betas (0.8 or less); the Materials, Telecom Services, and Technology groups were more volatile, registering betas of 1.2 to 1.6. Utilities, Telecom, Staples, and Financials were the highest yielders.

S&P 500 Sector Beta (60-month) % Chg. (60-month) Corr. with S&P 500 Div. Yld.
Consumer Staples 0.5 4.6 0.7 2.4%
Health Care 0.6 4.6 0.7 0.7%
Utilities 0.7 12.6 0.5 3.2%
Energy 0.8 22.9 0.4 1.5%
Industrials 0.9 10.8 0.8 1.9%
S&P 500 1.0 9.9 1.0 1.9%
Financials 1.0 7.7 0.9 2.8%
Consumer Discretionary 1.1 8.9 0.9 1.2%
Materials 1.2 13.7 0.8 2.0%
Telecom. Svcs. 1.5 12.8 0.8 3.1%
Info. Tech. 1.6 12.1 0.9 0.6%

Data as of July 27, 2007. Source: Standard & Poor's Equity Research

Rather than stop at the sector level, I decided to dig a little deeper for investment opportunities. I looked for those subindustries with low betas, relatively high dividend yields, and high aggregate S&P STARS, and then used the stock screening tool on to select component companies with low betas and high dividend yields that also have 4 STARS (buy) or 5 STARS (strong buy) recommendations by S&P analysts. Here are five groups I thought were worth considering:

Sectors Beta STARS Yield
Tobacco 0.8 4.9 4.2
Pharmaceuticals 0.6 3.8 2.9
Brewers 0.4 3.9 2.3
Soft Drinks 0.6 3.9 2.3
Water Utilities 0.2 4.0 2.2

Source: Standard & Poor's Equity Research

There is an old saying on Wall Street that when the going gets tough, the tough get eating, smoking, and drinking. Based on the list of subindustries and stocks with defensive characteristics, we can see how this adage came to be. Companies within these groups that met all three criteria included Abbott Labs (ABT, $50, 4 STARS), Altria (MO, $64, 5 STARS), Anheuser-Busch (BUD, $49, 4 STARS), AquaAmerica (WTR, $22, 4 STARS), Bristol-Myers Squibb (BMY, $28, 5 STARS), Coca-Cola (KO, $52, 4 STARS), Johnson & Johnson (JNJ, $60, 4 STARS), Merck (MRK, $50, 4 STARS), PepsiCo (PEP, $66, 4 STARS), and Reynolds American (RAI, $62, 4 STARS).

So there you have it—defensiveness in the face of decline. Since we think this recent market pullback will end up being a correction within a bull market, and not the start of a new bear market, we suggest investors consider these low-beta buys, as they offer an above-average dividend yield as we await an expected turnaround.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (7/27/07)
Auto Parts & Equipment Johnson Controls (JCI) 3 $110
Commercial Printing R.R. Donnelley (RRD) 4 $42
Commodity Chemicals Lyondell Chemical (LYO) 3 $45
Computer Hardware Apple (AAPL) 3 $144
Construction & Engineering Jacobs Engineering (JEC) 5 $60
Construction Materials Vulcan Materials (VMC) 2 $96
Consumer Electronics Harman Intl. (HAR) 4 $115
Diversified Metals & Mining Freeport McMoRan Copper (FCX) 2 $90
Fertilizers & Agr. Chem. Monsanto (MON) 3 $63
Footwear Nike (NKE) 4 $55
Internet Retail (AMZN) 2 $84
Semiconductor Equipment MKS Instruments (MKSI) 5 $23
Technology Distributors Arrow Electronics (ARW) 3 $38
Tires & Rubber Goodyear Tire (GT) 2 $27

Source: Standard & Poor's Equity Research

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