Stocks: Seeking Shelter from Volatility
That queasy feeling in investors' stomachs just won't go away.
A volatile stock market continues to knock share prices to and fro. One measure of volatility, the VIX index, remains at more than twice its historical levels.
Major stock indexes seem to be stuck in a trading range, staying above last year's lows but also failing to launch successful rallies. But within that wide trading range, stocks have plenty of room to make significant and unpredictable jumps higher or dives lower—something they've been doing regularly for months.
These wild swings, besides being unsettling, are a sign of the uncertainty and fear remaining in the market. "That's really a direct reflection of investor nervousness," says Terry Morris, a portfolio manager at National Penn Investors Trust Company.
The VIX index, which tracks the volatility of the S&P 500, closed at about 45 on Jan. 30. It was below 20 a year ago. The index typically trades in a range of 20 to 30, while more recently it has ranged from 40 to 80, notes Chris Johnson of Johnson Research Group.
The extreme swings are stressful and may put long-term investors at a disadvantage. "From a long-term perspective, volatility is not an investor's friend," Johnson says. "It's a trader's friend."
In the last few years before the financial crisis hit in mid-2007, volatility was especially low. "People got conditioned to a placid stock market," says Dan Crimmins, chief executive of DPC Wealth Management. "We went from calm [to] extremely volatile."
Where are the safe havens? Are there stocks that can protect investors from the wild swings gripping the entire market?
Certainly investors wary of volatility should stay away from financial stocks. "The banking stocks have become a trading vehicle, not an investing vehicle," says Quincy Krosby, chief investment strategist at the Hartford (HIG). The banking sector routinely makes double-digit moves in one trading session, recently by reacting to news from Washington regulators.
High-Beta Financial Stocks
One measure that may be a guide to finding less volatile individual stocks is "beta." Beta measures an individual stock's tendency to move along with the market. A stock with a beta of 1.0 perfectly tracks moves up or down in the broader market, represented by the S&P 500 index. A stock with a beta of 2.0 will move twice as much as the market, while a stock with a beta of less than 1 will resist the market's influence and move more independently.
BusinessWeek, using data from Capital IQ, examined the betas of stocks in the S&P 500, reflecting market moves over the last year.
Not surprisingly, financial stocks have some of the highest betas. Two of the most volatile stocks of the past year were bond insurer MBIA (MBI) and troubled banking giant Citigroup (C), both with betas of 3.2. They were closely followed by Office Depot (ODP), with a beta of 3.1, and Ford (F), with a one-year beta of 2.9.
But what about low-beta stocks? Might they provide some refuge from the volatility? Indeed, some stocks have been able to resist the market swings over the past year.
Tobacco's Rock-Steady Demand
The stock with the lowest beta in the S&P 500 is Altria Group (MO), with a one-year beta of 0.159. Not coincidentally, Reynolds American (RAI), another tobacco company, is the third least volatile stock, with a beta of 0.32. Cigarette manufacturers are disadvantaged by lawsuits and hounded by public health advocates, but they have one advantage from investors' standpoint: Because of the rock-steady demand for their product, revenues typically hold steady even in recessions. Strong cash flow helps Reynolds and Altria pay out generous dividends, which can support stock prices even in market turbulence.
The stock with the second lowest beta in the S&P 500 is Constellation Energy (CEG), a power producer and energy trader. Market turbulence in September hit Constellation and its trading operations hard, sending the stock down almost 60% in just a few days of trading. One reason for its low volatility, though, was a merger deal the company then struck with MidAmerican Energy, a deal that was later dropped in favor of a sale of assets to Electricite de France. As a result of these offers, Constellation held steady during late-2008's crazy market volatility, giving it a beta of 0.172 for the last year.
The fourth- and fifth-lowest betas in the S&P 500 belong to biotech companies. Amgen (AMGN) sports a beta of 0.366, while Genzyme (GENZ) has a beta of 0.384. Both are closely linked to the development of new drugs. Because customers will pay for life-saving drugs no matter the economic environment, the recent economic meltdown had less influence on these stocks than on others.
Not a Predictor of Volatility
But just because a stock is less volatile doesn't mean it's a great investment. Of these five stocks, only Amgen hasn't lost value in the last year. Also, the past year's beta is unlikely to be a guide to these stock's future volatility. For example, over the past five years—rather than just one year—Constellation has had a beta of 0.96, very close to the broader market.
The future volatility of a particular stock is especially hard to predict now, when market and economic conditions are changing rapidly, says John Merrill of Tanglewood Wealth Management. "Some stocks that may be high-beta stocks today were low-beta stocks two years ago. It's not constant over time."
In this market, there is no obvious place to hide from volatility. Corporate or government bonds are almost always less volatile than stocks, while the steadiest investment of all is cash, often placed in bank certificates of deposit.
So, investors who want a calmer ride than the stock market might need to choose an entirely different investment vehicle.