- September 18, 2020
- Posted by: Trading
- Category: FX for Beginners
Throughout periods of market disorder, stock traders look to safe haven stocks to weather the storm. Safe haven stocks also allow traders to diversify their portfolio and reduce risk.
This article will outline the following key concepts to help traders take advantage of safe haven stocks:
- Safe haven stocks defined
- Cyclical vs Non-cyclical stocks
- Best safe haven stocks to trade when markets are volatile
- Key things to consider when trading safe haven stocks
- Other safe havens to watch
What are safe haven stocks?
Safe haven stocks – also referred to as defensive/non-cyclical stocks – are stocks that are anticipated to preserve or increase in value during spells of market turbulence. This means they provide a low level of risk in times of economic uncertainty.
Safe havens stocks are sought after by investors and traders to limit their exposure to losses in the event of market downturns. However, stocks deemed ‘safe havens’ will alter over time as market conditions change.
It is important to note that the role of safe haven stocks is either to diversify a portfolio or simply beating depreciating market conditions.
Cyclical vs Non-cyclical stocks
Cyclical stocks are stocks that are highly correlated to the current economic climate. When the market is in a slump/recession, cyclical stock prices tend to fall. Equally, when the economy is flourishing these companies tend to increase revenue alongside a rising share price. E.g. automotive and airline companies such as Bayerische Motoren Werke AG (BMW) or Boeing Co.
Non-cyclical (safe haven) stocks refer to stocks that provide investors with a consistent return irrespective of the condition of the equities market. Safe haven stocks usually outperform the market in times of recessions but underperform during expansionary stages. These safe haven stocks can fall under three broad headings namely:
- Consumer staples
Utilities such as water, oil and electricity are requirements for consumers which make these companies preferred in a slow economic environment. Habitual consumer products are also favored as people tend to reliably purchase these items in all circumstances (hygiene, food and beverages). Lastly, healthcare is a perpetual throughout any financial, economic or social circumstance. E.g. Southern Company, PepsiCo Inc and Pfizer Inc.
Popular safe haven stocks to trade when markets are volatile
The best safe haven stocks to trade through volatile markets will fall under the aforementioned defensive stock subcategories. Below is a bulleted list of common safe haven stocks under each category.
- NextEra Energy Inc
- Southern Company
- York Water Company
- New Jersey Resources Corporation
- Cabot Oil & Gas Corporation
Consumer staple stocks:
- Procter & Gamble Company
- Coca-Cola Company
- Walmart Inc
- Philip Morris International Inc
- Costco Wholesale Corporation
- Johnson & Johnson
- Pfizer Inc
- Merck & Co Inc
- United Health Group Inc
Key things to consider when trading safe haven stocks
Most often, trading safe haven stocks is used as a defensive tool to weather a fading economy as even defensive stocks may not yield a positive return.
Slow economic conditions allow safe haven stocks to outperform the rest of the stock market however, this does not translate into profits. There are several factors to consider when identifying and trading safe haven stocks:
Trader’s should consider the beta of a stock prior to investment. The beta refers to the correlation between the stock and the market. A beta value of one indicates price is strongly correlated with the market. A beta value greater than one signals a security is more volatile than the market, while a low beta value (closer to zero) have less association with markets conditions. This will allow for traders to hedge against increased volatility.
As a general rule of thumb, it is considered that stocks with high dividend yields (greater than 6%) are great cases for safe haven stocks. These companies have a perception of keeping their value during erratic periods. Dividends also provide a fixed source of income which is often invested back into the company through dividend reinvestment plans.
3) P/E ratio:
Safe haven stocks are renown for being undervalued in terms of their P/E ratios. P/E ratio is the ratio of a company’s share price to the company’s earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued. Stocks with lower P/E ratios are seen as undervalued or outperforming relative to past movements which makes these shares ideal candidates as safe haven stocks.
4) Large established companies:
Reputable companies that have been cemented into the stock market are also exceptional candidates for a safe haven product. This is because people tend to stick to these established brands and have confidence in the company even during a period of price decline. These types of stocks generally lose less value than mid or small cap shares in recessions.
No one factor is dominant over another. Traders need to do thorough research and analysis prior to selecting safe haven stocks. All factors above should be scrutinized to derive the most suitable shares for the risk appetite of the portfolio.
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Safe haven FAQ section
What are the differences between safe haven stocks and defensive stocks?
Safe haven stocks and defensive stocks are interchangeable terms that refer to the same non-cyclical stock activity. Novice stock analysts and traders should not be perplexed by varying stock jargon. This extends to many other areas of financial markets which can seem daunting. Extracting complex terms from the equation will help novice traders analyse the essential aspects of the stock market.
Other safe havens to watch
Safe haven assets are not isolated to the equity market alone. Traders can look to other financial markets for security against downturns, such as forex and gold. Read our guide to safe haven currencies or follow the links to other safe haven assets below: