While stocks may technically be in the midst of their fifth week of gains following the early October pullback, the reality is, they’re once again overbought and ripe for a pullback. It won’t be the beginning of a bear market, mind you, so a hysterical panic isn’t in order. On the other hand, it’s not going to just be a couple days of malaise either.
The prod for said pullback? Among other things, the market’s valuation. As of Wednesday, the S&P 500’s trailing price-to-earnings ratio is a frothy 19.2. That’s oddly high compared to the long-term historical average of 15.35, or even the recent (10-year) average of 16.95.
Even without the valuation conundrum though, it’s clear the rally has run out of steam. The S&P 500 has only gained 1.4% over the past two-and-a-half weeks, versus a 6.9% advance over the course of the first two full weeks of the rally. Sooner or later, stocks are simply going to run out of gas.
The $64,000 question: Which stocks are the best stocks to buy when it all comes tumblin’ down? Here are five to consider.
Best Stocks to Buy: Exelon Corporation (EXC)
It’s admittedly cliche, but cliches have become cliches for a reason … because there’s something to them.
If and when the broad market pulls back, traders are apt to see the usual save havens as the best stocks to buy. And, there’s no better safe haven than utility stocks. The best bet in that bunch right now is Exelon Corporation (EXC).
At a trailing P/E of 14.8, it’s cheaper than the majority of its peers, and the dividend yield of 3.5% looks pretty compelling too, when it looks like non-dividend-paying stocks have nothing to offer investors.
Best Stocks to Buy: Procter & Gamble Co (PG)
It’s almost as cliche as seeking out utility stocks to shield yourself from market weakness, but consumer staples stocks fare better in turbulent times too. The theory is, things like soap, diapers and food are going to be purchased no matter how dire the economic situation becomes.
Truth be told, it’s a misguided premise to employ if the only goal is to defend against a short-term pullback. The necessity of consumer staples — the reliability of their revenue –– would only truly matter if stocks entered a full-blown bear market and staples names had a couple of quarters to prove their resiliency. As long as enough investors are willing to employ the misguided premise though, it works to push the sector’s stocks up during a short-term rough patch for the market.
Procter & Gamble Co (PG), being the quintessential name in consumer staples arena, tops the list of staples stocks to buy because it offers the most stability when the market gets rocky.
Best Stocks to Buy: SPDR Gold Trust (ETF) (GLD)
Click to Enlarge While it’s not always true that gold moves in the opposite direction as the broad market, lately, the commodity and the equity market have been diametrical partners. Odds are good they’ll remain inversely linked for a while longer, too.
The easiest way for the average investor to make such a play is with the SPDR Gold Trust (ETF) (GLD). The inverse correlation between GLD stock and the SPDR S&P 500 ETF Trust (SPY) over the past several weeks is clear on the chart of both — along with the U.S. dollar index — below.
The X-factor here is the U.S. dollar. At least some of the recent weakness from GLD has to be attributed to the dollar’s sharp rise in value. That may actually augment the upside of the SPDR Gold Trust, however. The greenback looks like it’s starting to peak, and if it rolls over, that too will put bullish pressure on GLD and push it to the top of the list of potential stocks to buy when most other stocks are melting down.
Best Stocks to Buy: ProShares UltraShort S&P500 (SDS)
Leveraged ETFs are dangerous enough already, but when a leveraged ETF is designed to move in the opposite direction as the broad market, it opens a whole new can of psychological worms. All the same, for investors who are confident they can buy high and sell low, an inverse leveraged fund like the ProShares UltraShort S&P500 ETF (SDS) can justifiably be added to a list of defensive stocks to buy for some people.
The ProShares UltraShort S&P 500 is a double-leveraged inverse fund, meaning for every 1 percentage point the S&P 500 index falls, the fund is designed to advance 2 percentage points on a daily basis.
Always keep in mind the danger of such leveraged ETFs, but if you’re willing to take on the risks, the value of such a tool is clear, even if only used as a hedge.
Best Stocks to Buy: iShares MSCI Canada Index ETF (EWC)
Last but not least, if the goal is simply avoiding the impact of a correction for U.S. stocks, look overseas for good stocks to buy. Specifically, look for exchange traded funds that hold stocks from countries that are not closely linked with the U.S. economy. Ideally, that foreign market should be backed by a firm economy.
Right now one of the most quietly impressive overseas economies is Canada, which makes the iShares MSCI Canada Index ETF (EWC) one of the best defensive names should the U.S. market take a nosedive.
Despite the country’s modest 0.1% contraction of its GDP in August (the most recently-reported quarter), the GDP trend is still going strong, while its inflation rate of 2.11% isn’t teetering on the edge of deflation. Meanwhile, Canada is becoming a net exporter again, creating a trade surplus of $710 million in September after a long streak of heavy net imports between 2008 and 2013.
Should U.S. stocks hit a wall, odds are good investors will flock to their healthier neighbors to the north, via the iShares MSCI Canada Index ETF.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.