Defense is the Best Offense

Date: September 26, 2011

by Rieve Ko, SIAS Research @ September 26th, 2011

Investing in recent times has been tough. Fears of a Greek default and anemic economic growth have kept investors and traders alike on the edge, in spite of encouraging rhetoric and policy proposals from politicians. While the real impact of the Federal Reserve’s “Operation Twist” will only be clear months later, the Fed’s note of “significant downside risks” to the economic outlook dealt the markets another blow last week.

The MSCI world index continues to trend lower (as of last Thursday) while the Dow Jones Industrial Average (DJIA) remains mired in a bearish flag formation after plunging below its crucial support level of 12,000 close to two months ago. As we trudge through the difficult month of September, investors would do well by adopting a defensive stance and remembering a stock market maxim that works – “Defense is the best form of offense.”

At times of high volatility, defensive sectors such as Consumer Staples, Healthcare and Utilities offer good investment opportunities for the risk-averse. Funds have been flowing into these defensive sectors since the DJIA hit its last high of 12,753 on 7 July 2011. Year to date returns for some ETFs (listed in US) on the Consumer Staples, Healthcare and the Utilities sectors came in at 5.32%, 4.79% and 9.42% respectively, outperforming the DJIA, which was down 1.34%.

Investors can also consider having some Asia Ex-Japan infrastructure funds in their portfolio. They provide diversification benefits to investors and reduce overall investment risk. Studies have shown that such funds have low correlation with other asset classes. Additionally, developing countries like India, Indonesia and China are in good stead to enjoy robust infrastructure demand, making these funds even more attractive.

Technical analysis for the DJIA shows that it is currently forming the second shoulder of its head and shoulders (HNS) pattern on dwindling volume. Selling pressure will be high in that area and could potentially force the Dow to move even lower. When that happens, it could prove detrimental for both emerging markets (except for the defensive sectors) and the commodity sector. Hence, we will continue to underweight emerging markets and the commodity sector and overweight on defensive assets such as Asian bonds, Australia money market funds, consumer staples and infrastructure ETFs.

The Dow Jones Industrial Average: