The Flight to Safety Could Burn You

Last Monday, the Dow dropped 777 points, the greatest one-day point drop in history and the biggest percentage loss since September 2001. This Monday, the Dow dropped as many as 800 points before recovering some of that back prior to the closing bell.

Year to date, the S&P 500 is down more than 30%. Investment banks are no more, credit is largely frozen, housing prices continue to drop, unemployment continues to rise, food and oil prices are creeping still higher, and Congress has taken extreme measures to try to turn things around.

What are investors doing? According to The Boston Globe, investors are largely fleeing the markets for what have historically been less-risky investments such as CDs, money markets, and short-term Treasuries -- even as interest rates on the Treasuries sunk below 1%. In fact, year to date, stock mutual funds have lost net nearly $68 billion, while taxable bond mutual funds have gained net nearly $72 billion.

If there were ever a time for a defensive play, you'd think this would be it. And in fact, a lot of ink has been spilled this year touting the virtues of classic defensive plays such as Pfizer (NYSE: PFE  ) , Coca-Cola (NYSE: KO  ) , Johnson & Johnson (NYSE: JNJ  ) and Procter & Gamble (NYSE: PG  ) -- some of it on this website.

After all, the story goes, even when times are tough, people will still eat, they'll still heat their homes, and they'll still buy their medicines.

But if you've been putting your money in blue-chip consumer staples, pharmaceuticals, and utilities on the theory that it will be relatively safe there, you may want to think again.

First, it's not working
While defensive plays may have worked in previous downturns, they aren't working in this one. The collapse of the financial markets only intensified already-existing economic strains on the American family, including rising food prices, rising heating oil prices, rising foreclosure rates, and rising unemployment.

The American family is having to make choices -- and the old standbys are often on the chopping block.

For example, The Wall Street Journal is reporting that the number of prescriptions filled in the U.S. fell 0.5% year over year during the first quarter of the year -- and fell 1.97% during the second. It's the first time prescriptions have fallen in at least a decade. And that's not all: A survey by the National Association of Insurance Commissioners said that 22% of consumers are going to the doctor less often because they just can't afford it.

Food prices are increasing at the fastest rate since 1990, also according to The Boston Globe. And a USA TODAY/Gallup poll from April reported that 46% of Americans were experiencing increasing food prices as a financial hardship. And prices have only gone up.

All of this is having a negative effect on "defensive" stocks. Drug manufacturers are down 19% year to date, food manufacturing is down 18%, and grocery stocks are down 30%. Even utilities aren't escaping: Electric utilities are down 33%, and water utilities are down 38%.

While a couple of these sectors haven't lost you as much money as the market at large, there's still a clear trend: down, down, down.

Even the strongest stocks in those categories have struggled. Pfizer is down 19% year to date, Safeway is down 33%, UnitedHealth Group (NYSE: UNH  ) has lost 65%, and Walgreens (NYSE: WAG  ) has lost 29%. Even Coca-Cola is down 18%.

It turns out that when things get bad enough -- and a collapsed housing market, rising food prices, and a shaky financial sector count as "bad enough" -- people do cut back on even the essentials.

In other words, while a defensive play may cushion the blow, it really isn't going to save your portfolio right now.

Second, it's a bad strategy
But even when macroeconomic factors don't conspire against the defensive play, it's still not a good strategy for your money.

Essentially, a defensive play is a "next hot sector" play -- only when times are tough, investors are content to find the "next not-as-bad sector" instead of the next hot one. But just as chasing hot performance will likely leave you empty-handed, investing in defensive plays when times are tough just because they're defensive plays will undermine your long-term returns. Why?

  1. It's historical, not forward-looking. The "next hot sector" is only apparent after it's warmed up -- and that means it's likely to cool down. Just ask anyone who was invested in tech stocks in early 2000 -- just because it was hot doesn't mean it was sustainable. And just because so-called defensive stocks are in historically stable industries doesn't mean the companies or the industry in question won't be rocked by events no one saw coming. Remember, up until this year, financials were believed to be defensive stocks, too.
  2. It doesn't focus on the company. Even assuming an industry holds up against downward market pressure, it doesn't mean an individual company will come out smelling like a rose -- and just because a sector takes a nosedive doesn't mean a company will. Adobe Systems (Nasdaq: ADBE  ) , for example, has returned 22% annually over the past 10 years -- bypassing the tech bust entirely.

The Foolish bottom line
So if you want to stay in stocks (and if you have money you don't need for the next five years, you should), where you should invest? Rather than trying to find stocks that won't lose very much in the turmoil, you should be looking for companies with excellent management, strong competitive advantages, excellent prospects, and strong balance sheets -- because those will outperform over time, even if the near-term still looks stormy. Buying and holding is still the best choice for the majority of your portfolio -- especially when so many stocks are trading at unbelievable lows.

That's what we're doing at Motley Fool Pro, the new investing service that opened yesterday -- but that's not all we're doing. Fool co-founder David Gardner and his Motley Fool Pro team are investing $1 million in a portfolio designed to make money in any market.

In the coming weeks, the team, relying heavily on proprietary CAPS "community intelligence" data, will establish long and short positions in a broad range of securities, including common stocks, publicly traded put and call options, and exchange-traded funds (ETFs). To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.

At the time of publication, Julie Clarenbach had no stake in any company mentioned in this article. Pfizer, Coca-Cola, and UnitedHealth are Motley Fool Inside Value recommendations. Pfizer and Johnson & Johnson are Income Investor choices. UnitedHealth and Electronic Arts are Stock Advisor picks. The Motley Fool owns shares of Pfizer and UnitedHealth. The Motley Fool's disclosure policy plays offense, not defense.


Read/Post Comments (14) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 08, 2008, at 5:19 PM, MacMcFarland wrote:

    And what if a stock falls into both the "defensive" category AND the "strong balance sheet, market advantages, etc." category? E.g., 23% of Pfizer's current market cap is backed by cash, it pays 7% dividends, and as long as capital markets are clogged, the world's largest pharma company is in a position to buy up products cheaply. You can "defend" while looking "forward" to a steady stream of increasing dividends.

  • Report this Comment On October 08, 2008, at 6:08 PM, radarlen wrote:

    this is all well and good--but what does one do when the titans of business and the politicians turn out to be spineless greedy self indulgent parasites==like the aforementioned--I dont think you understand that we have lost all respect and confidence in you, business, politicians. you folks are so far removed from the real world i doubt that you people could ever connect with reality--capitalism is fine--but unchecked greed is not good. there seems to be no one of integrity to tell the truth. shame on you.

  • Report this Comment On October 08, 2008, at 7:55 PM, chantillydude wrote:

    I've been in treasuries since last Thanksgiving. So are my daughter and my wife. We're about to selectively begin to buy equities again after the election and inauguration.

    None of us has lost a penny in nearly a year which is far different than any Motley Fool portfolio can demonstrate. Our philosophy has become "don't lose money" and that means don't bet against long term world wide macro factors, including market meltdowns.

    Five years is forever, for example, five years ago Wachovia, AIG, Lehman Bros, Ford, GM, Bear Stearns, were all viable companies and market capitalism was a philosophy.

  • Report this Comment On October 09, 2008, at 12:14 AM, ReadyToPlay wrote:

    Hats off to you Chantillydude! Time for you to start a newsletter.

    My wife went 50% cash over a year ago. She bought a lot of CDs at decent rates. I thought she had lost her mind. (I am grateful that she doesn't rub it in.) I just didn't get it. I was Foolishly buying as the "good" stocks dropped into what I thought was a very fair price - based on TMF newsletters and Morningstar. And those stocks kept on dropping over the year.

    Anyone else think we seem to be in uncharted territory and heading further down?

  • Report this Comment On October 09, 2008, at 7:27 AM, CIGA wrote:

    The ultimate flight to safety is gold bullion. It's simply a substitute for cash and the currency of last resort. It has no liabilities and no counterparty risk. It's simply a currency that's been around for thousands of years. The most conservative thing you can do these days is buy gold.

  • Report this Comment On October 09, 2008, at 7:56 AM, wjo1948 wrote:

    While Chantillydude has made a safe play by going into treasuries since last Thanksgiving, he could have done even better by choosing IShares Lehman Treasury Bond Funds. Since last October, the IShares Lehman 10-20year and 20+year Treasury Bond Funds have returned over 10% on your money. Plus if Chantillydude truly felt the market was heading drastically south last Thanksgiving, he should have been shorting the Financials and the DOW30,S&P500,and the NASDAQ.

  • Report this Comment On October 09, 2008, at 8:44 AM, vest0r2 wrote:

    Gold, canned food and ammunition. I don't think we're in Kansas anymore, Toto.

  • Report this Comment On October 09, 2008, at 1:07 PM, plouf wrote:

    So should I cut my losses and just take money out of some old Janus tech funds & stocks such as TRV, WMB, & TWEIX and ladder some CD's or put them in treasuries of some kind - or just let them sit there for five-ten years until they come back - then cash out and never trust or invest with the greedy corporate world again?

    Along with all of my family and friends, I have never racked up mortgage or any debt, as I have never developed a taste for owning as much crap that I can't realistically afford.. (except for my stock investments) and my time in the stock market has been nothing but a huge loss of hard earned money. As Dana Carvey put it "Bye-bye 401-K.."

  • Report this Comment On October 09, 2008, at 1:36 PM, Daddyg3042 wrote:

    And as ReadyToPlay, I too thought Foolish advice provided some 8-12 mos. ago was a prudent move, but as it turns out, I was the fool for taking it.

    Read what the Econ's are saying, not the brokers, and be very cautious in taking Foolish advice.

  • Report this Comment On October 09, 2008, at 2:04 PM, plouf wrote:

    Daddyg3042 - Any recommendations on which economists to read? Paul Salomon on the NIghtly News w/Jim Lehrer, perhaps?

  • Report this Comment On October 10, 2008, at 11:47 AM, EMS9Tech wrote:

    So right, radarlen, but we've been warned about unbridled greed from the beginning!

    "We have no government armed with power capable of contending with human passions unbridled by morality and religion. Avarice, ambition, revenge, or gallantry, would break the strongest cords of our Constitution as a whale goes through a net. Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other". John Adams, October 11, 1798

  • Report this Comment On October 10, 2008, at 5:19 PM, capitalletters wrote:

    I've seen greed, and it is all of us.

  • Report this Comment On October 10, 2008, at 7:48 PM, SilverMoney wrote:

    Gold and silver look like excellent buys...if you can find any. The dollar is toast, over the next 6-12 months hyper inflationary pressures will take their toll on the purchasing power of the once almighty dollar. We have expanded our money supply 8% in a mere 3 weeks...this is going to lead to higher prices for just about all must have items, like food gas and energy. Only precious metals will wither the coming tsunami of inflation, hope you got in early like yours truely.

  • Report this Comment On October 14, 2008, at 4:03 PM, CIGA wrote:

    If you want no spin and only the truth about the current situation please check out jsmineset.com -- it's not many places where a world class trader will guide you for free. And yes, buy gold if you can find any.

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