The Flight to Safety Could Burn You

Last September, the Dow dropped 777 points, the greatest one-day point drop in history and the biggest percentage loss since September 2001. Since then, 81% of trading days have exceeded the historical daily price movement of the index.

The S&P 500 is nearly 50% off its highs of October 2007. Investment banks are no more, credit is largely frozen, unemployment continues to rise, and Congress has taken extreme measures to try to turn things around.

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, unprecedented 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 2008 -- 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 continue to rise, and a USA TODAY/Gallup poll recently reported that Americans' self-reported spending continued to fall.

All of this is having a negative effect on "defensive" stocks. Drug manufacturers are down 19% over the past year, food manufacturing is down 35%, and grocery stocks are down 28%. Even utilities aren't escaping: Electric utilities are down 33%, and water utilities are down 32%.

While a couple of these sectors haven't lost you quite 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 27% over the past year, Safeway is down 32%, UnitedHealth Group (NYSE: UNH  ) has lost 37%, and Walgreens (NYSE: WAG  ) has lost 18%. Even Coca-Cola is down 28%.

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, for example, has returned 13% 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 using 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 click here.

This article was originally published on Oct. 8, 2008. It has been updated.

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. Johnson & Johnson is an Income Investor choice, while Pfizer is a former one. UnitedHealth is a Stock Advisor pick. The Motley Fool owns shares of UnitedHealth and Procter & Gamble. The Motley Fool's disclosure policy plays offense, not defense.


Read/Post Comments (3) | Recommend This Article (12)

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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 March 22, 2009, at 6:31 PM, gwconcord wrote:

    100% disagree! Two percent fewer prescriptions filled = 33% decline in stock price? These stocks pay reliable dividends, and the fact that they are down so much makes them seem like value plays to me (and the Motley Fool, too, given the disclosure at the end of the article indicates some of these companies are Motley Fool Inside Value picks). The author is writing off entire industries without examining any fundamentals, or indicating that there is a price where these companies would be good value.

  • Report this Comment On March 23, 2009, at 2:44 PM, stockgeek54321 wrote:

    I cannot believe you ran this article again. Let me see excellent management, strong competitive advantage, excellent prospects......if these characteristics do not describe ko, jnj, pg and to some degree, pfe, then i don't know what companies will. If you buy shares of these companies on a regular basis, you will get great returns over the next 10-15 years, ESPECIALLY IF THE PRICES OF THESE STOCKS CONTINUE TO GO DOWN.

    I wrote a comment on this same article a few months ago because were contradicting your other services.

  • Report this Comment On April 03, 2009, at 3:07 PM, TimothyVR wrote:

    This is a strange post.

    There is no reference to the international exposure of any of the companies or to the dividends, as gwconcord mentions - the two major attractions of the stocks mentioned.

    And what about the end of the recession and the next expansion? Most of us who are buying these stocks are intending to hold them for a a while.

    Also, I will echo chinaboy's comments about excellent management, price and competitive advantage.

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