Monday, December 26, 2011

Performances of Defensive Stocks from Pre-Crisis to 2011

Defensive stocks are those that perform well during a period of economic slowdown. They generally do not outperform the market during periods of rapid economic growth, and thus serve as low-risk securities. A MSN article from May 2010 lists 14 "safe stocks to stock up on." Of the 14, three are currently listed on the Dow Jones Industrial Average. They include Johnson and Johnson (NYSE: JNJ), which is involved in health care products, Proctor and Gamble (NYSE: PG), which focuses on consumer packaged goods, and Wal-Mart (NYSE: WMT). The historical performances of these stocks from mid-2008 to present were retrieved and analyzed. For comparison, similar data were retrieved for two companies not part of the Dow: Google (NYSE: GOOG) and Caterpillar (NYSE: CAT), and the Dow Jones Index itself. The results are as follows:

Name High Low Decrease Current Increase
JNJ 72.22 46.60 35.47% 65.98 41.59%
PG 73.15 44.18 39.60% 66.67 50.91%
WMT 63.17 46.42 26.52% 59.99 29.23%
GOOG 685.33 257.44 62.44% 633.14 145.94%
CAT 115.41 22.17 80.79% 92.25 316.10%
DJI 13058.20 6626.94 49.25% 12294.00 85.52%

Indeed, as the figure shows, during the financial crisis of late 2008 and early 2009, the percentage decrease from the highest closing trades to the lowest closing trades was the greatest for Google and Caterpillar, which are not defensive stocks. Then came the Dow index, which featured a mix of defensive and non-defensive stocks. Finally, the three defensive stocks saw the smallest decrease during those economic downturn times. On the reverse, as the economy has been recovering over the past 2+ years and stock prices have been increasing again, the three defensive stocks saw the smallest percentage gain, while Google and Caterpillar both saw enormous gains, with the Dow motley in the middle.

All this goes to say is that defensive stocks have low risk and variance. In good times, they return less than the others, but in bad times, they don't lose as much as the others. Wal-Mart's low variance is exemplified in an even more profound way by realizing that its post-crisis trough was hit on February 2009; however, that price of 46.24 was actually higher than that during January 2008, and wasn't far off from the prices during much of 2006 and 2007, when the economy was growing strongly. Defensive stocks usually cover common products, used whether the economy is growing or shrinking. Think of the sectors the defensive stocks here cover: healthcare, consumer package, and retail, all of which are rather basic necessities and face relatively inelastic demand. In all, coming together in a group of ideas are: defensive stocks, common goods, necessities, inelastic demand, low risk, low variance, low returns, and low losses. Whether these are better than other stocks will ultimately depend on the state of being of the macroeconomics.

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