For the first time in over 10 months, the stock market is showing signs of fatigue.
In a roughly one-month stretch from early September to early October, the benchmark S&P 500 (^GSPC 0.63%) shed about 5% of its value. It's a drop in the bucket compared to the index's gains since the March 2020 bear-market bottom, but it's a potentially stern reminder that a stock market crash or double-digit correction could be around the corner.
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Fundamentally speaking, a crash or correction appears likely
To be clear, it's impossible to predict with any long-term accuracy when a crash will occur, how long it'll last, or how steep the decline will be. But given the frequency of moves lower in the market throughout history, warning flags should be raised.
Fundamentally speaking, there is a trio of worrying metrics. First, margin debt has soared in 2021. Margin debt describes the amount of money borrowed with interest to purchase or short-sell securities. According to data from market analytics company Yardeni Research, there have been only three instances since the beginning of 1995 where margin debt jumped 60% or more in a single year. The previous two instances occurred right before the dot-com bubble burst and months before the financial crisis that caused the Great Recession.
Second, inflation is picking up in a big way. Crude oil settled at its highest close in seven years this past week, while the core Consumer Price Index, which excludes food and energy, surged by its highest rate in about three decades. While some level of inflation is positive for a growing economy, high rates of inflation can stifle consumer spending and bring economic growth to a halt.
And third, S&P 500 valuations are stretched. As of Oct. 12, the S&P 500's Shiller price-to-earnings (P/E) ratio stood at 37.6. The Shiller P/E takes into account inflation-adjusted earnings over the past 10 years. What's concerning from a valuation perspective is that in the previous four instances where the S&P 500 has surpassed a Shiller P/E of 30, it's eventually gone on to lose at least 20% of its value.
History says we could be headed for trouble, too. Following each of the previous eight bear-market bottoms, dating back to 1960, the S&P 500 has undergone either one or two declines of at least 10% within three years. In other words, bouncing back from a 20% or greater drop in the broader market is a process that takes time. The fact that the market has gone almost straight up doesn't jibe with history.
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Buy these safe stocks in the event of a stock market crash
While the idea of a stock market crash or even an orderly double-digit correction might not be palatable to some investors, it's important to recognize one key fact: All crashes and corrections are buying opportunities for patient investors. Every single notable move lower in the S&P 500 has eventually been erased by a bull-market rally.
But going on the offensive during a big move lower in the market doesn't mean you have to buy stakes in volatile companies. If a stock market crash or steep correction does occur, the following three companies are some of the safest stocks you can buy and still profit from the recovery.
Duke Energy
Sometimes, boring companies are the perfect place to put your money to work during periods of heightened volatility. Electric utility stock Duke Energy (DUK 0.50%), which is substantially less volatile than the benchmark S&P 500, is one example of a very safe stock long-term investors can buy if a crash rears its head.
The great thing about electric utilities is that they provide a basic need service. No matter how well or poorly the U.S. economy or stock market are performing, homeowners and renters need electricity or natural gas. With the understanding that demand for electricity and natural gas doesn't change much from one year to next for existing households and businesses, Duke Energy is able to outlay capital for new projects without having to worry about a negative effect on earnings or its market-topping dividend, which is currently yielding 4%.
What's exciting for Duke and its shareholders is just how much capital the company is putting to work in new infrastructure projects. In particular, most of the $60 billion the company aims to spend between 2020 and 2024 will go toward renewable energy solutions. Although investing in wind and solar isn't cheap, it does dramatically lower long-term electricity generation costs. As a result, Duke Energy expects its compound annual growth rate to climb to between 5% and 7%. For some context, most electric utilities grow by a low single-digit percentage.
Duke Energy is far from flashy, but its high yield and predictability of cash flow should help conservative investors build wealth over time.
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Johnson & Johnson
Another extremely safe stock that can be confidently bought by investors during a stock market crash or correction is healthcare conglomerate Johnson & Johnson (JNJ -0.06%). Similar to Duke Energy, J&J is less volatile than the broader market, and it, too, pays a superior dividend (2.7% yield). In fact, Johnson & Johnson has raised its base annual payout for 59 consecutive years.
Healthcare stocks like J&J are highly defensive. Since we don't get to decide when we get sick or what ailment(s) we develop, the demand for pharmaceuticals, medical devices, and healthcare services tends to remain constant no matter what's going on with the U.S. economy or stock market. This is a big reason why J&J once had a streak of more than 35 consecutive years with adjusted operating earnings growth.
What really makes Johnson & Johnson tick are its three operating segments -- consumer health products, medical devices, and pharmaceuticals -- each of which brings something important to the table. Consumer health is the slowest-growing, but it provides predictable cash flow and generally strong pricing power. Meanwhile, medical devices is perfectly positioned to take advantage of an aging U.S. and global population. Lastly, pharmaceuticals have a finite period of exclusivity, but brand-name drugs are responsible for much of J&J's growth and operating margin.
The icing on the cake with J&J is that it's one of only two publicly traded companies with the coveted AAA credit rating from Standard & Poor's. That's a higher credit rating than the U.S. government.
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Alphabet
Just to mix things up, a third and final safe stock investors can buy if the market crashes or steeply corrects is high-growth tech stock Alphabet (GOOGL 0.96%) (GOOG 0.84%). Alphabet, the company behind the Google internet search engine and streaming content platform YouTube, is right on par with the broader market's volatility and is likely to be buoyed by its nearly $108 billion net cash position.
Alphabet's foundational business has long been its Google search engine, which defines dominance. According to GlobalStats, Google has maintained between 91% and 93% of global internet search share for the trailing two-year period. This makes it the go-to platform for advertisers, which are more than willing to pay big bucks for prime placement on search pages.
The company is also generating sustainable double-digit growth from YouTube and Google Cloud. YouTube has become one of the most visited social sites in the world, while Cloud has clawed its way to the global No. 3 in cloud infrastructure service spending. Cloud, in particular, should generate beefier margins than ads, which makes it a key driver of operating cash flow for the future.
Ultimately, Alphabet is a company that benefits from long-winded periods of expansion. Any dip is the perfect opportunity for patient investors to pounce.
