Frank Curzio's WALL STREET UNPLUGGED Podcast

3 defensive stocks for a volatile market

Volatility has spiked over the last few days—a sign the market is getting riskier.

Growth stocks finished lower Monday, with the Nasdaq Composite experiencing its biggest drop in nearly two months. And the selloff spread to cyclical stocks on Tuesday, as investors focused on the sharp rise in inflation numbers. 

Inflation concerns aren’t likely to go away anytime soon, so I expect this volatility to continue for at least the next few months.

And while some traders thrive in a volatile market, most investors want to avoid sharp swings, especially to the downside. 

Today, I’ll explain how to pick safer companies with stocks that will hold up better in volatile conditions. And I’ll reveal my three favorite low-volatility stocks that you can buy right now.


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Volatility is ramping

For most of 2021, U.S. stocks have been hitting—or hovering around—new all-time highs. Investors have been bullish about the improving economy. 

However, a surging economy usually leads to higher prices for houses, cars, and everyday products. And the latest inflation numbers have spooked a lot of folks. Two of the most widely followed inflation gauges are the Producer Price Index (PPI) and the Consumer Price Index (CPI). For the month of March, the PPI posted its largest increase in 10 years, while the CPI jumped to its highest reading since 2018.

Inflation makes it harder to forecast future business results. In other words, it creates extra uncertainty for stocks. And as you probably know, the market hates uncertainty. Plus, rising inflation could lead the Fed to raise rates ahead of schedule. Higher interest rates are another negative factor for most businesses… and for the stock market. 

That’s why we’re seeing pressure across multiple sectors, including growth stocks and cyclicals. Volatility creates fear, which can drive investors to sell holdings to avoid further losses. This creates even more losses.

Put simply, inflation is stirring this volatility… and I’m afraid it’s going to be an issue for a while.

How to find “safer” stocks

In situations like this, investors must consider safer holdings—also known as defensive stocks. This category includes companies with modest but steady business growth. These stocks rarely make big moves up or down. But they’re much more likely to outperform growth stocks when market volatility ramps up. 

I covered this idea a few months ago, when I wrote about four defensive ETFs to consider during turbulent times. Back then, I wrote:

The best defensive positions exhibit lower volatility than the rest of the market. They also attempt to reduce the impact of falling markets. The goal is simple: to keep your portfolio stable when the market hits a rough patch.

There are a few features I look for in a defensive stock…

  1. High institutional ownership

When a stock has high institutional ownership, it’s a bullish sign. It means the “smart money” favors the stock. These institutional investors are typically long-term holders. They don’t dump their positions when the market gets a little rocky. So a stock with high institutional ownership is less likely to see a big price swing.

  1. Low beta

Beta is a measure of a stock’s volatility compared to the overall market. If a stock has a beta of 1, it means it goes up and down about the same as the market. I want stocks with a beta below 1, which means they’re less volatile than the market.

  1. Fundamentally sound

We can check this by looking at the company’s balance sheet to make sure it has enough cash compared to its debt. I also want to avoid stocks with sky-high valuations. These “high fliers” are more likely to see big price swings. 

  1. Strong long-term performance

Lastly, I want stocks that are in a long-term uptrend… and preferably outperforming the S&P 500. 

By focusing on companies with these attributes, we can avoid risky stocks that could plunge during a bear market. The goal is to find stocks that perform well in any market. These defensive stocks will help protect your portfolio, while also offering solid upside potential. 

Here are my three favorites right now…

Cummins Inc. (CMI)

Cummins is the largest engine maker in the world. The company manufactures diesel and natural gas engines, as well as powertrain components. Cummins has benefited from the recent rally in industrial stocks, which helped the stock double over the past year.

The company has been expanding its alternative energy business lines. For example, it acquired Hydrogenic Corp., a leader in fuel cell and hydrogen production technologies. By focusing on these alternative energy sources, Cummins will benefit as the engine market moves away from traditional combustion technology. 

Looking at the near term, Cummins has a surprisingly strong growth profile. Management projects full-year 2021 revenue to increase 20–24% year-over-year (YoY). The company also has a strong balance sheet, with cash and cash equivalents around $3 billion. That’s up from $1.7 billion a year ago.

Cummins fits everything we’re looking for in a safer stock. It has a beta below 1, low debt, and a high institutional ownership percentage (86.2%). 

Shares of Cummins easily outperformed the S&P 500 over the past five years, gaining 178% vs. the S&P’s 123.8% gain. Despite this outperformance, shares of Cummins trade at a reasonable valuation, with a forward price-to-earnings ratio (P/E) of 17.3. 

I’m very bullish on industrial stocks right now. And Cummins’ shares are super-cheap considering it’s the dominant player in its industry. This is a must-have stock for any portfolio.

Landstar System (LSTR) 

Landstar is a third-party logistics provider focused on trucking. The company delivers specialized transportation services to a broad range of customers utilizing a network of over 1,200 independent sales agents. Landstar focuses on “asset-light” solutions, which means it doesn’t own a fleet of trucks. Instead, it matches its customers with third-party providers.

Due to the recovery in the economy, the freight market is booming. This helped Landstar recover from the coronavirus-driven slump in 2020. The company’s top and bottom lines have increased for three straight quarters. And the company delivered record results for both revenue and earnings for the first quarter of 2021.

Landstar should continue to benefit from strong consumer demand and tight trucking capacity. The company also has a strong liquidity position, with cash and cash equivalents of $261 million. This cash position is more than twice its current debt ($108 million).

Similar to Cummins, Landstar is outperforming the S&P 500. Over the past three years, Landstar has gained 73.5%, compared to a 64.1% increase for the S&P 500. In terms of valuation, Landstar has a forward P/E of 21.1, making it relatively cheap considering the fact that trucking activity will surge as the economy recovers from the pandemic… setting Landstar up for additional gains.

When you add a low beta and a very high number of institutional investors, this stock is a great pick for any market condition.

Watsco, Inc. (WSO) 

Watsco is the largest distributor of HVAC and refrigeration equipment in the U.S., with a 15% market share. The company has more than 400 locations in 38 states and serves more than 40,000 contractors and dealers. 

Demand for HVAC equipment can be cyclical, but when something goes wrong with heating or air conditioning, customers typically want it fixed ASAP. This creates steady business for Watsco in a good or bad economy.

Watsco’s digital sales platform for HVAC/R contractors, OnCall Air, generated $105 million in gross merchandise value for customers in the first quarter—up 111% YoY. In layman’s terms, gross merchandise value is the total value of goods sold through an e-commerce channel. And Watsco’s financing platform, CreditForComfort, processed more than 1,000 financing applications last year—a 31% increase over the previous year. 

Watsco has paid a cash dividend to its investors for 47 consecutive years, making it a great dividend play. It has a very low beta, a strong balance sheet, and a solid history of outperforming the S&P 500.

If you’re looking for a company that generates consistent growth, offers income, and is less volatile, WSO is a fantastic pick.

Taking action

If you’re like me and concerned about volatility, you must consider defensive stocks like the three I mentioned. Your retirement savings may depend on it. 

Cummins, Landstar, and Watsco are all leaders in their industries. Their businesses are fundamentally sound. And their stocks have lower volatility than the market.

By adding one or more of these stocks to your portfolio, you’ll help lower your risk compared to the market. This way, you can stay invested… while protecting yourself during volatile times

David Cohne has over 20 years of experience as an investment analyst and writer. He's consulted for hedge funds, financial services companies, and written for various financial news publishers. David also served as Director of Research for The Rankings Service and worked in portfolio management at Adviser Investments.

Editor’s note:

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