For athletes, "defense wins championships," at least according to legendary football coach Bear Bryant. But for investors, a solid defensive plan protects you against the extremes of bear markets. And more importantly, defining your bear market plan before the financial markets go sideways can keep you from losing your cool and making short-sighted trading decisions.
The core of any bear market defensive strategy should be securities that are less prone to volatility. Treasury bonds and cash have a role to play, but so do stocks of very large, mature companies -- also known as "safe stocks." Of course, there's no such thing as a stock that's 100% safe. However, stable organizations that have already proven they can manage through rough times are usually good bets when the market goes sideways. Here are three of those defensive positions.
1. Apple
Apple (AAPL -0.57%) has size on its side, for sure. The iPhone maker has a market capitalization in excess of $2 trillion, making it the world's largest company.
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Apple does have a fair amount of debt, and its debt-to-equity ratio has doubled since 2018. While that trend isn't ideal, the risk is tempered by Apple's ability to produce cash. The company has recorded more than $58 billion in free cash flow in each of the last three years. Apple also has more than $70 billion in cash and cash equivalents on its balance sheet.
What Apple truly has going for it, though, is customer loyalty. The suite of Apple products works cohesively, which encourages customers to continue buying technology within the iOS ecosystem. And the deeper customers get into that ecosystem, the harder it is to switch away. That's the formula for consistent demand through all economic climates.
2. Coca-Cola
Coca-Cola (KO 0.68%) is the world's largest nonalcoholic beverage company, with a portfolio of 200 brands and distribution in more than 200 countries and territories. Coke doesn't produce as much cash as Apple, but the performance is fairly consistent -- usually between $6 billion and $9 billion in free cash flow annually.
A good chunk of that cash funds dividend payments. The company is a stable dividend payer, and that stokes ongoing demand for its stock.
Carbonated beverage sales have been declining over the last few years, and the pandemic did cut into Coke's core fountain drink business. But Coke has a seasoned leadership team, good operating margins, and a massive global distribution network on its side. Recent moves to launch new can sizes on legacy Coke products and acquire smaller brands with steeper growth potential (like Costa Coffee) position the company well for the future.
3. Walmart
Walmart (WMT -0.65%) is the world's largest retailer, generating $523 billion in sales in 2020 -- outshining Amazon's sales by more than $100 billion. The company operates about 10,500 retail stores in 24 countries and is also scaling a sizable e-commerce business.
Walmart, too, is a cash-generation machine. Annual free cash flow in excess of $14 billion is enough to fund dividends at a sustainable payout ratio of about 40%. Plus, there's cash left over for e-commerce acquisitions and technology innovations to streamline the online customer experience.
The retailer has also positioned itself to thrive in economic pullbacks. Walmart and Sam's Club stores are low-price leaders, and customers flock to them to stock up on necessities -- especially when times are tight. That dynamic is ideal for bear market investors. As we saw through the coronavirus recession and the Great Recession, Walmart can thrive while other retailers struggle.
The chart below shows Walmart's share price relative to the S&P 500 during the first half of 2020. You can see that Walmart powered right through the broader market decline that hit so many other companies last March.
How to use safe stocks
Big companies with good leadership, a lengthy track record of performance, loyal customers, and reliable cash flow are often the workhorses of bear markets. But they can -- or should -- anchor your portfolio in good times, too.
That's because bear market defense is not a strategy to deploy after the market goes sideways. These "safe stocks" aren't the positions you want to trade often. You'll do better by holding them for the long term. That way, you capitalize on their slow-and-steady growth trajectory. And, you'll enjoy their stabilizing effect when the market takes a turn -- without having to sell your growth-oriented positions at a loss.
