Which stocks will protect you from a FTSE 100 meltdown?
The FTSE 100 has been making new all-time highs this year but one thing we know about markets is that they never rise in a straight line. Sooner or later there'll be a sharp correction (a temporary fall of 10%-plus) or, less frequently, a bear market -- a prolonged fall in excess of 20%.
One way to mitigate the impact of a falling market on your portfolio is to have a good proportion of lower-beta stocks among your holdings. The market's beta is one and if a stock has a beta of less than that, it's theoretically less volatile than the market. For example, a stock with a beta of 0.75 will swing 25% less than the market.
Big consumer goods companies whose strong brands inspire loyalty among customers typically have low betas. According to financial data site Digital Look, Reckitt Benckiser(LSE: RB), whose stable of brands includes Dettol antiseptic, Cillit Bang cleaner and Durex condoms, has the lowest beta (0.5) of the Footsie's consumer goods firms.
Other notable companies in the sector, all with betas of 0.6, are Reckitt's rival Unilever, drinks giant Diageo and tobacco firms British American and Imperial Brands.
During the last great bear market of 2007-09 the FTSE 100 fell by 48% in under 18 months. Reckitt's shares declined by just 14% over the same period. Investors are willing to pay a premium price for the relative stability of consumer goods giants and Reckitt trades on a forward P/E of 22, with a 2.3% dividend yield. I believe this is a premium worth paying.
Regulated utilities also typically have low betas. National Grid(LSE: NG) and water companies Severn Trent and United Utilities all have betas of 0.5. During the 2007-09 bear market, their shares declined 27%, 33% and 36%, respectively, compared with the Footsie's fall of 48%.
National Grid currently trades on a forward P/E of just over 15, with a juicy prospective yield of 4.6%. The shares are some 15% below their 52-week high and look very buyable to me at this level.
According to the data from Digital Look, the two FTSE 100 companies with the lowest betas are Fresnillo(LSE: FRES) at 0.3 and Randgold Resources at negative 0.3.
If you've followed the share prices of precious metals miners at all, you'll know they can be highly volatile. You may be wondering why they have low betas. The answer is that while a beta below one can indicate a stock with lower volatility than the market, it can, alternatively, indicate a volatile stock but one whose price movements are not highly correlated with the market. At the extreme, a stock with a negative beta is one that tends to go up when the market goes down, and vice versa.
When there's fear in the equity markets -- as we saw in the aftermath of the Brexit vote -- the prices of precious metals, and the companies that mine them, typically rise.
As the outlook for the UK isn't currently anywhere near as dire as was initially feared at the time of the referendum, the shares of Fresnillo and Randgold have retreated from their highs. Fresnillo is 32% off its peak of last year and Randgold 29%. Fresnillo appears marginally more attractive on this basis but they are on similar valuations and I rate both stocks a buy.
G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo, Imperial Brands, and Reckitt Benckiser. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.