Market corrections occur when the broad market (S&P 500, Nasdaq and the Dow Jones Industrial) declines at least 10%. In a correction, many stocks will decline even more than that, especially stocks that were overvalued or extremely popular prior to the correction.
But not everything goes down during corrections! Some safe haven investments become more popular during corrections, and see their prices rise as investors move money from riskier places to safer places. These safe investments vary from the nearly loss-proof, like short-term treasury bills, to the countercyclical, like consumer staples stocks.
But let’s get a bit more specific…
Fixed income investments are the classic safe haven, and the bond market often moves opposite the stock market. However, many individual investors—those investing through retirement plans, for example—will already have a fixed income allocation in their portfolio. Where can you turn when the market gets rocky other than fixed income?
Luckily, many institutional investors can’t (or won’t want to) move all their funds to cash or fixed income either. Actively managed equity funds, for example, may want to reduce risk, but they’re limited by their mandate to primarily invest in equities. Their only option is to shift their money to safer stocks. Many institutional investors are in similar situations, and these inflows can make the safest stocks go up when most other stocks are going down!
These types of stocks can come from almost anywhere, but they tend to have a few commonalities. Here are a few of the traits that can make a stock act like a safe haven during turbulent times.
Low Volatility
Volatility is basically a proxy for risk. Stocks that are more volatile have larger price swings, percentage wise. Beta, while not a perfect science, is one measurement of volatility: it compares the average prices moves of a stock to the average moves of a benchmark (usually the S&P 500). A beta of less than 1 means the stock is less volatile than the benchmark, while a beta of more than 1 means the stock moves more than the benchmark. A negative beta means the stock is negatively correlated to the benchmark: they move in opposite directions more often than not.
Industry
Some stocks are more cyclical than others, meaning they’re tied to industry or economic cycles. Oil stocks, for example, are very cyclical. Stocks that are closely tied to economic growth or the health of financial markets will often fall more than the broad market during downturns. Conversely, countercyclical stocks will fall less than the market during downturns. Classic countercyclical industries are consumer staples and utilities, because demand for their products is highly independent of economic conditions.
Dividends
Many stocks that act as safe havens are also attractive as long-term investments because they pay reliable dividends. Dividends are an indicator of reliability: they mean the company’s business generates predictable income during a variety of economic conditions. They also attract long-term investors who are more focused on income than stock prices.
All investors enjoy bull markets. Investing is a lot more fun—and easier—when the market is going up. But nothing goes up forever, and all investors will inevitably live through some market pullbacks, corrections, and even a few bear markets. That’s why it’s essential to have a few safe investments in your portfolio.