Invest in the best defensive stocks with low correlation to SPY with Interactive Brokers.
The S&P 500 index is regarded as the barometer of U.S. stock market performance. Composed of large-cap U.S. equities, the S&P 500 index is often used as a benchmark for professional and retail investors to compete against. When it comes to funds, the SPDR S&P 500 ETF (NYSEARCA: SPY) is the largest and most liquid exchange-traded fund (ETF) for tracking the S&P 500. Here are the best defensive stocks with low correlation to SPY.
One investment strategy with the potential to outperform over long periods is buying stocks that have a low correlation coefficient to SPY. This metric is primarily measured by the stock's beta, which also incorporates measures of the stock's volatility. The market (in this case, the S&P 500 or SPY) has a beta of 1.0, while stocks can have a beta of:
- Above 1.0, meaning that the stock generally moves in the same direction as the market and in a more volatile fashion
- Below 1.0 but higher than 0.0, meaning that the stock generally moves in the same direction as the market but in a less volatile manner
- At 0.0, meaning that the stock generally moves in a way uncorrelated to the movements of the market
- Below 0.0, meaning that the stock moves inversely to the market and in a more volatile fashion as it gets more negative
Best Defensive Stocks With Low Correlation to SPY
The following defensive stocks all have a low correlation coefficient (beta of 0.50 or under) compared to the SPY. In addition, these stocks exhibit sound fundamentals in the form of positive return on equity; return on assets; return on investment; and gross, operating and net margins. They also have positive historical earnings and revenue growth. A combination of quality characteristics plus a lower-than-average beta makes these stocks potential defensive picks.
1. Procter & Gamble Co. (NYSE: PG)
With a market cap of $330 billion, PG is one of the largest consumer defensive companies in the world. The company provides an array of essential products to consumers worldwide via five segments: beauty; grooming; healthcare; fabric and home care; and baby, feminine and family care. PG has achieved a strong network effect through its robust distribution network consisting of mass merchandisers, e-commerce, grocery stores, membership club stores, drug stores, department stores, distributors, wholesalers, specialty beauty stores and pharmacies. Currently, the company has a five-year monthly beta of 0.34, making it a third as volatile as the overall market. Since 1993, PG has outperformed the SPY with a compound annual growth rate (CAGR) of 10.95% compared to 9.72% with all dividends reinvested.
2. Merck & Co. Inc. (NYSE: MRK)
Merck is a company operating through two main healthcare sectors: pharmaceuticals and animal care. For the former, MRK offers various human pharmaceutical products related to oncology, immunology, neuroscience, virology, cardiovascular and diabetes. For the latter, MRK discovers, develops, manufactures and markets veterinary pharmaceuticals, vaccines and health management services such as identification and tracking devices. Worldwide, MRK collaborates with other healthcare companies to develop and commercialize vital medications, including HIV/AIDS treatments. Currently, the company has a five-year monthly beta of just 0.34, making it a third as volatile as the overall market and placing it among one of the best value stocks. Since 1993, MRK has underperformed the SPY with a CAGR of 9.54% compared to 9.72% with all dividends reinvested.
3. Bristol-Myers Squibb Co. (NYSE: BMY)
BMY is another long-standing healthcare company known for developing, licensing, manufacturing and marketing various pharmaceutical products. Notable examples include its cancer treatments, which treat lymphoma, myeloma and leukemia. The company sells products not only to wholesalers but also directly to pharmacies, hospitals, clinics and government agencies. Currently, the company has a five-year monthly beta of 0.45, making it slightly less than half as volatile compared to the overall market. Since 1993, BMY has underperformed the SPY with a CAGR of 9.44% compared to 9.72% with all dividends reinvested.
4. American Tower Corp. (NYSE: AMT)
AMT is one of the largest North American-based real estate investment trusts (REITs). The company boasts a portfolio of around 219,000 cellular communications sites, from which it gains lease income tied to the performance and growth of the communications sector. Its major lessees include AT&T Inc. (NYSE: T) and T-Mobile US Inc. (NASDAQ: TMUS). Despite falling hard during the 2000 dot-com bubble, the company has rallied strongly in recent years thanks to the 5G boom. The company has a five-year monthly beta of 0.49, making it around half as volatile compared to the overall market. Since 1999, AMT has outperformed the SPY with a CAGR of 10.43% compared to 6.95% with all dividends reinvested.
5. General Mills Inc. (NYSE: GIS)
GIS was incorporated in 1928 as a flour miller. Over the century, the company has expanded to become one of the largest suppliers of cereals and pre-packaged foods worldwide. GIS is known for its large selection of products, with famous brands such as Fruit Gushers, Cinnamon Toast Crunch, Cocoa Puffs, Nature Valley, Pillsbury, Yoplait, Wheaties and Cheerios being pantry staples across America. The company distributes products via a robust network of grocery stores, mass merchandisers, membership stores, natural food chains, e-commerce, convenience stores, pharmacies and discount retailers. Currently, the company has a five-year monthly beta of 0.32, making it a third as volatile as the overall market. Since 1993, GIS has outperformed the SPY with a CAGR of 9.81% compared to 9.72% with all dividends reinvested.
6. McDonald’s (NYSE: MCD)
Founded in 1940 and headquartered in Chicago, Illinois, McDonald's operates and franchises McDonald's restaurants in the United States and internationally, where the company offers hamburgers and cheeseburgers, chicken sandwiches and nuggets, fries, salads, shakes, frozen desserts, sundaes, soft serve cones, bakery items, soft drinks, coffee and beverages. There’s also a breakfast menu, including muffins, sausages, biscuit and bagel sandwiches, oatmeal, hash browns, breakfast burritos and pancakes. A solid diversification benefit of having McDonald's in your portfolio is it can provide considerable resilience to business cycles and unforeseen market drawdowns.
Benefits of Low-Correlation Investing
Investing in low-correlation stocks can be a good way to insulate your portfolio from the broader market's movements. For investors with lower risk tolerance, investing in low-correlation stocks can help reduce volatility and ensure a more consistent sequence of returns. It can also help protect previous investment returns and reduce drawdowns, which is how large a peak-to-trough loss is for an investment portfolio.
Lower Market Risk
Market risk is the risk that volatility in the broader stock market can affect the value of your investments. Market risk is unavoidable unless you only hold cash, but it can be mitigated by holding stocks with a low correlation coefficient to the SPY. For example, while the S&P 500 lost over 16% in 2022 from inflation and Federal Reserve rate hikes, all the stocks mentioned earlier (except for AMT) have returned positive so far thanks to their lower beta. During the 2020 COVID-19 crash, most of these stocks plunged less too, albeit still more than Treasury bonds.
Low beta stocks tend to also have a lower standard deviation. This is the amount that a stock has historically moved around its average. For example, a stock that has returned 10% over the last decade with a standard deviation of 20% has fluctuated in value between -10% to 30% at times. Keeping standard deviation low by picking low-beta stocks can help your investment compound at a steadier rate without the violent ups and downs. Over the long term, keeping unrealized losses minimized can play an important role in increasing total returns. To illustrate this, consider how a 33% loss from $100 to $66.66 requires a subsequent 50% gain of $33.33 to break even again.
Better Portfolio Risk-Adjusted Returns
Modern Portfolio Theory states that a portfolio of uncorrelated assets with positive expected returns can produce more return for less risk compared to a single asset. For your asset allocation plan, incorporating low correlation into a diversified portfolio of stocks, bonds, cash and alternatives can help investors optimize their risk-adjusted returns further by dampening volatility without sacrificing performance. Often, adding low stocks with a low correlation to SPY or the broad market can increase a portfolio's Sharpe ratio, a measure of risk-adjusted returns.
Benefits of Investing in Defensive Stocks
Defensive stocks are those with traits that help them endure during difficult economic or market conditions. Often, this translates into a competitive business advantage that ensures their margins, revenue and earnings stay healthy. Defensive stocks tend to be found in the consumer staples and healthcare industries because of their evergreen demand and essential nature. Investing in these stocks can be desirable for investors with a lower risk tolerance or shorter time horizon.
Defensive sectors like healthcare and consumer staples tend to lag during low-interest rate bull markets but can strongly outperform during times of high inflation or rising interest rates. GIS, MRK, BMY and PG all returned positive in 2022 (as of September) despite the broader market being in the red. Of these stocks, both MRK and BMY are healthcare sector companies, while GIS and PG are consumer staples. The evergreen demand and essential nature of these companies help ensure their revenues, earnings and margins stay relatively intact during times of economic stress.
Investors looking for higher-than-average income might like defensive stocks. Because defensive stocks are often those of mature, blue-chip companies, they tend to have surplus cash reserves that they pay out quarterly to investors as a dividend. Often, the dividend yield from these companies exceeded the average offered by the SPY ETF. Dividends from U.S. companies are generally taxed at a more favorable rate, making them tax efficient. Reinvesting these dividends plays an important role in compounding total returns.
Prolonged bear markets are difficult to endure for even experienced investors. Having some stocks that remain in the green while the overall market is in the red can be a much-needed psychological boost for investors. Investors who need to withdraw money from their portfolios for income can sell shares of these companies first to avoid locking in an unrealized loss. This can sometimes mean the difference between staying the course and remaining invested instead of capitulating and panic-selling.
Compare Stock Brokers
Investors looking for further insights and reviews of defensive low-correlation stocks can use Benzinga to compare the available options. Here is also a list of brokers where you can invest in defensive stocks.
Protect Yourself from Uncertainty
Investing in low-correlation stocks with strong fundamentals is beneficial for many investors. The stocks listed here demonstrate low volatility and market risk, evident from their low beta values. These stocks tend to excel during market downturns and exhibit resilience to business cycles. Defensive stocks offer attractive dividend yields, which can result in income generation and improved risk-adjusted returns. These stocks provide investors with a sense of security during market declines and help safeguard against unnecessary risks.
Frequently Asked Questions
Are defensive stocks low risk?
Defensive stocks are considered lower risk compared to the broader market but should not be interpreted as being “low risk” compared to other asset classes, such as bonds or cash. Even the most robust blue-chip, low-beta stock with less volatility can still tank sharply during a broad market crash. As with investing in all stocks, a degree of market risk is unavoidable. Moreover, investors need to be aware of idiosyncratic risk, which is the risk of loss in their investment because of changes in the company’s fundamentals or outlook. Even the most solid of defensive stocks can suffer changes in management, poor sales or a scandal that causes their share price to sharply drop.
What is a low correlation for stocks?
In general, stocks that have a low correlation to the market exhibit a historical beta of less than 0.50. Between 0 to 0.50, stocks will still move in the same direction as the overall market, but to a muted and more infrequent degree as beta gets lower. When beta goes negative, the stock has historically moved in the opposite direction of the stock market. A good way to screen for stocks with a low correlation to the market is by looking for those with a beta between 0 to 0.50. Keep in mind that the beta will depend on the historical period under consideration, so testing a varied sample is a good idea.
Are defensive stocks a good investment?
Whether or not defensive stocks are a good investment depends on an investor’s objectives, risk tolerance and time horizon. For example, a young investor with many years until retirement may opt for a portfolio of growth stocks or a broad-market index fund. This investor can tolerate some volatility in exchange for the potentially higher returns taking on additional risk brings. Thus, the investor may not want to limit themselves to low-correlation defensive stocks, which might severely restrict their stock picks by ignoring certain sectors (like technology stocks) or market caps (like small cap stocks). On the other hand, a retiree might opt for their stock allocation to be composed of low-correlation defensive stocks. For this investor, keeping volatility minimized is critical for ensuring the protection of principal and a safe withdrawal rate.