Embrace the Low-Volatility Bonanza

by Tyler Craig | March 27, 2013 10:43 am

Embrace the Low-Volatility Bonanza

Despite the S&P 500 being a stone’s throw away from a new all-time high and stocks continuing their impressive bull run, leadership has emerged from an unsuspected corner of the playground — consumer staples.

Long considered a safe haven, the consumer staples sector is supposed to put on its best performance during tumultuous periods when investor fears are on the rise. These stocks’ more stable nature makes them prime candidates for defensive investors more concerned about protecting capital than maximizing returns.

Top contenders in the staples space include Proctor & Gamble (NYSE:PG[1]), Altria Group (NYSE:MO[2]), Walmart (NYSE:WMT[3]) and Coca Cola (NYSE:KO[4]) — not exactly a band of volatile gunslingers.

As shown in the accompanying performance chart, the Consumer Staples SPDR (NYSE:XLP[5]) was the leading sector over the past three months, besting the gain in the S&P 500 by 4.47%. It also has been the top sector for the past week (not shown).

sectorcomparison Embrace the Low Volatility Bonanza[6]

Most traders use beta to measure just how volatile a particular stock is relative to the market. The S&P 500 — which we’ll use as the official proxy of the market — has a beta of 1. Any stock with a beta larger than 1 will be more volatile than the market, and any stock with a beta below 1 will be less volatile.

Of the aforementioned members of the consumer staples sector, Coca-Cola has the highest beta of 0.51, which effectively means the stock is theoretically about 50% less volatile than the market. On a day where the S&P 500 falls 2%, Coca-Cola should only fall about 1%. Conversely, if the S&P 500 were to rise 2%, Coca-Cola should only rise about 1%.

The Powershares S&P 500 Low Volatility Portfolio (NYSE:SPLV[7]) presents a unique way of tracking low-volatility stocks not only in the consumer staples sector, but also in the utilities sector, healthcare and elsewhere. While the SPLV has been climbing alongside the broader market this year, it only recent began outperforming more volatile stocks.

SPLVchart 300x240 Embrace the Low Volatility Bonanza
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The following chart shows a ratio of SPLV versus the S&P 500 High Beta Portfolio (NYSE:SPHB[8]) which is an exchange-traded fund heavily weighted toward volatile stocks in sectors such as financials and information technology. When the ratio is rising, SPLV is outperforming SPHB; when the ratio is falling, SPLV is underperforming SPHB.

Since July 2012, the ratio has been declining as traders have poured into high-beta stocks in true risk-on fashion. The continued outperformance of these more volatile securities drove the ratio lower until mid-February 2013. Since then, the ratio has begun climbing, forming a higher swing low (blue arrow) and showing the potential for a trend reversal. If the ratio can break above the downtrend line (black dotted line), further upside should be in the offing.

PGchart 300x233 Embrace the Low Volatility Bonanza
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The recent upturn in the performance of these low-volatility stocks is one development driving the strength in consumer staples. While the sector might be overbought, some individual components like Procter & Gamble have formed compelling setups over the past month.

The consolidation in PG has taken on the form of an ascending triangle, which sets up a nice breakout trade over the $77.75 resistance zone. If you’re looking to play the continued resurgence of low-volatility players like PG, consider buying the June 77.50-80 bull call spread for around $1 when the stock breaks above resistance.

To initiate the position, buy the June 77.50 call and sell the 80 call. The max risk is limited to the initial $1 paid, and the max reward is the distance between strikes minus the debit, or $1.50.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. PG: http://markets.financialcontent.com/investplace./quote?Symbol=Pg
  2. MO: http://markets.financialcontent.com/investplace./quote?Symbol=MO
  3. WMT: http://markets.financialcontent.com/investplace./quote?Symbol=WMt
  4. KO: http://markets.financialcontent.com/investplace./quote?Symbol=KO
  5. XLP: http://markets.financialcontent.com/investplace./quote?Symbol=XLP
  6. [Image]: http://investorplace.com/wp-content/uploads/2013/03/sectorcomparison.png
  7. SPLV: http://markets.financialcontent.com/investplace./quote?Symbol=SPLv
  8. SPHB: http://markets.financialcontent.com/investplace./quote?Symbol=SPHB

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