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Afraid of a Market Selloff? Hide in This Defensive Stock

Small bank stocks should be shielded in case of a market selloff


During the past few days, we have heard constant chatter about last week’s decline in the stock market. Some feel that it is just a minor bump in the road while others worry that it might be the start of a larger, more sustained selloff.

Fears of a credit crisis from the shadow banking industry in China as well as emerging market currency concerns have the market somehwat jittery. On Monday we saw many of the big momentum names like Twitter (TWTR) and LinkedIn (LNKD) see some selling pressure as investors and traders apparently think the risk outweighs the rewards in a potentially vulnerable market.

The gurus and pundits are starting to discuss places to hide in the market and suggesting that it is time to move toward more defensive sectors and stocks like big oils and utilities.

I suspect that if we get a sustained decline, these hiding places will turn out not to be as defensive as hoped. As long as the big names are in the indices and ETFs that traders will use to sell the market, they will move lower with the stock market. These are just the type of large liquid names that will be sold by hedge funds to meet margin calls and mutual funds to decrease their equity exposure.

If you are concerned about market conditions, a better hiding place might be in the smaller regional and community bank stocks.

They are less liquid than their large cap brethren and the large funds tend not to own them. The funds that do own them are going to be value and activist funds that are more likely to be buyers than sellers in a severe market decline. In addition, there is a growing M&A trend in the sector that can provide upside potential in these stocks regardless of market direction.

Many of them trade below book value and pay dividends. In fact, as credit conditions continue to improve, these little banks should provide dividend growth at a well above average clip for the next several years. In just the last week we have seen 10 smaller banks raise their dividend payout by 10% or more.

Westfield Financial (WFD) is a good example of such a stock. The bank has been in existence since 1853 and has eleven branches in western Massachusetts. The shares trade at about 90% of book value right now, and the dividend yield is currently a comfortable 3.3%.

WFD is buying back stock in the open market and just announced a new 5% buyback. None of the big hedge funds have a position in the stock, and the mutual funds that own it are primarily index funds who won’t be sellers in a market decline.

Most traditional hiding places will probably show a high degree of correlation with the broader market. High-frequency and ETF traders sell indiscriminately without considering sector or industry groupings.

With NYSE margin levels flirting with pre-crisis levels, it is worth remembering that the more liquid a stock is the more liley it is to be sold to meet a margin call in a bad market. Small banks will not face that type of selling pressure, and there are solid trends in place that could cause them to buck the trend and move higher even in a bad market.

As of this writing, Tim Melvin was long WFD.

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