Introduction

To hedge against excessive fluctuations, it is worth considering defensive strategies and defensive investing. Particularly in times of the coronavirus crisis, Donald Trump with his unpredictable moods and tweets that send markets reeling and geopolitical uncertainties that are more volatile than ever before, it is worth taking a moment to sit back and think about how you can protect your money, at least to some extent. If you don’t do this, you will celebrate jubilations when prices rise, but fall into deep depression and a crisis of meaning when minor or major crashes occur (which they inevitably do) if you haven’t prepared yourself a little. Then the level of suffering becomes so high that you don’t even want to watch the courses any more – I speak from personal experience. You see the cases and your hard-earned money literally swimming away, and very helplessly at that.

Well then, what tools can help you position yourself more defensively without being completely left behind in a bull market because you were too cautious?

The classic – Gold

Gold is probably recommended by everyone to protect yourself. However, physical gold in the form of gold bars is inconvenient, requires you to pay storage costs (vault at home or at a bank), involves a risk of theft at home and must be insured. In addition, a real bar of gold always costs more than the same amount as “paper gold”. And buying/selling can be a hassle with additional fees and costs.

Yes, physical gold is an option, but not necessarily the best one.

As an alternative, you could buy gold ETFs (Exchange Traded Funds), the best known of which is probably the ticker GLD (SPDR Gold ETF). This is traded with a very high liquidity (approx. 1 billion US$ per day) and tracks the price of gold bars, minus small fees for managing the ETF, as is usually the case. In my opinion, this option is significantly cheaper than physical gold and is therefore recommended if you want to bet on gold.

Another option is of course to trade gold futures. However, this is only recommended for advanced, experienced traders and investors and I am simply listing it here for the sake of completeness.

Important: Be aware that gold usually, but not always, moves countercyclically to equities. Gold also correlates strongly with oil, but this is not the case in 2020. Gold is also heavily dependent on the dollar; a strong dollar is bad for gold, a weak dollar is good.

If equities fall, gold rises, and vice versa. This relationship also almost always works. Gold is good in a recession, and especially when interest rates are low. The higher interest rates are, the less attractive gold becomes. The current low and even negative interest rate regime is sure to continue for some time. This will certainly support the gold price.

The coronavirus crisis and the dramatic fall in oil prices in the first half of 2020 in particular have shown that gold does not always react rationally. With the fall in the oil price, equities also fell dramatically and the general expectation was that gold would rise sharply. This was not the case at the beginning of the crash, and gold also fell with it. The reasons are not entirely clear, but countries are likely to have sold massive amounts of gold to raise cash and offset the oil price losses (Saudi Arabia, USA, Russia, Iran, etc.).

Classic 2.0 – Cash

When volatility rises and share prices fall, it is better to get out of some stocks and keep your cash, even if it means short-term losses. If the shares are even in profit, it makes sense to take profits if there are signs of turbulence. Another option would be, for example, to sell only 100 of a block of 200 shares to be on the safe side in order to minimize your equity risk and still convert a theoretical profit into a real one.

However, should a real bear market set in or simply a longer, deeper price correction begin, it is sometimes better to reduce share portfolios somewhat and rely on safe cash. Then you will also have money to hand again quickly if there are signs of a recovery. In such a case, you can get back in without further ado and benefit from rising prices again.

In addition, it always makes sense to have a certain amount of cash in your trading portfolio so that you can seize a favorable opportunity immediately and do not have to scrape together money from somewhere or transfer it to your account first. Often the good opportunity has already passed by then.

The percentage of cash in the portfolio should not be too high, because we want to invest and trade and earn money with it, and not just place money statically in an account. I think 10% freely available cash is normally sensible, and in volatile stock markets this value can certainly increase considerably through profit-taking with the sale of shares. It certainly depends on how big and how long the turbulence can be expected to last. Don’t feel guilty if you have more cash than normal in your portfolio for a while. The motto is: safety before risk! Sometimes you need patience and patience to wait calmly for the right time to re-enter the market.

Gold variant – Goldminers

Gold mining companies are an alternative to investing in gold ETFs or physical gold. They often also have a dividend, which generates additional income. Mining companies often not only mine gold, but also other precious or industrial metals such as copper, palladium, etc. Well-known mining companies include:

• Barrick Gold (Ticker: GOLD)
• Freeport McMoran (Ticker: FCX)
• Vale (Ticker: VALE)
• Rio Tinto (Ticker: RIO)
• Newmont (Ticker: NEM)
• Kinross Gold (Ticker: KGC)
• BHP Billiton (Ticker: BHP)
• Franco Nevada (Ticker: FNV)

The dividends of stocks such as FCX in particular are quite attractive, while pure gold miners usually have modest dividends of less than 1%.

However, it is important to bear this in mind: Unlike gold, the prices of such companies often behave somewhat irrationally. Pure gold mining companies often go with the general market and not necessarily with the current gold price. If the market falls sharply, these shares can also fall sharply, even though the gold price may remain stable or even rise. The shares are sucked into the abyss with the masses, so to speak. In addition, companies such as Freeport McMoran, Vale, Rio Tinto and BHP Billiton also mine copper, for example. Copper is very cyclical and dependent on the economy. If the economy is doing badly, the demand for copper (and most industrial metals) falls, and with it the share prices of these companies.

It is therefore important to understand what a mining company produces. If it is a pure gold mining company, the link to the gold price is relatively close. Nevertheless, there can be contradictory movements. Mining companies can therefore generally only be described as defensive to a limited extent. And if they are, then you are better off sticking with precious metal companies such as Newmont, Barrick Gold, Kinross Gold or Yamana Gold.

Now we’ve gone through the usual suspects. Some nice information, but no big surprises. So let’s move on to other options for a defensive portfolio.

Backbone Stocks (Stalwarts)

What the heck are backbone stocks? These are stocks that should be in every portfolio. They are large companies that are stable, pay a high dividend (at least 3%), have a low or moderate level of debt and also have a low beta factor. Such a low beta value shows that the share moves more slowly than the market and is therefore only subject to extreme fluctuations to a limited extent.

We have compiled a list of such stocks for you. If well-known companies are missing (e.g. pharmaceutical giant Johnson&Johnson), this is because they do not meet the above criteria. These have been defined by us, but J&J in particular would also be such a stable stock, albeit with a dividend of less than 3%.

You can find out more about backbone stocks (Stalwarts, Pfeiler) here. You are of course free to add more stocks, but you should apply certain criteria to ensure that the stocks really offer protection against volatile market movements.

The current list of backbone stocks can be found here under Stalwart Stocks.

Geographical diversion

Our service focuses on stocks listed on US stock exchanges, but of course also includes companies from abroad. Stable, conservative stocks from different regions offer you excellent diversification. Here I can think of stocks such as Honda (ticker: HMC), Toyota (ticker: TM), Unilever (ticker: UN or UL), Petroleo Brasileiro (ticker: PBR), Softbank (ticker: SFTBY), Takeda (ticker: TAK) or Royal Dutch Shell (ticker: RDS.A or RDS.B) or BP (ticker: BP). BP (ticker: BP), AstraZeneca (ticker: AZN), Telefonica SA (ticker: TEF), Mondelez (ticker: MDLZ), Novartis (ticker: NVS), UBS (ticker: UBS), British American Tobacco (ticker: BTI), Diageo (ticker: DEO), Nestlé (ticker: NSRGY), Prudential (ticker: PUK).

All of these stocks offer good, in some cases even excellent dividends and are the right size to withstand crises. They are regionally dispersed and from various sectors, ideal for diversifying your portfolio.

US Treasuries (like TLH, TLT)

Such securities (Treasury Bills/Notes) are US government bonds and normally move in the opposite direction to the stock market. In a weak stock market, investors want security and rush into these bonds. However, as these also yield interest, rising bond prices reduce interest income. However, if share prices rise sharply, the bonds fall, as many investors also invest more in profitable shares again. However, this at least increases the interest income from bonds.

You can buy US Treasurys yourself as a non-US resident (e.g. via Treasurydirect.gov).

However, the better option is to buy Treasury bonds directly via a trader such as TD Ameritrade. This is as easy as with other bonds or shares and is also possible for foreign investors.

A third option is offered by exchange-traded funds ETFs that track the price performance of US Treasury bonds. A well-known example is the iShares 10-20 Years Treasury Bond ETF (ticker: TLH), the iShares Barclays 1-3 Years Treasury Bond ETF (ticker: SHY), the Vanguard Long-Term Government Bond ETF (ticker: VGLT) or the SPDR Portfolio Long Term Treasury ETF (ticker: SPTL).

All three of these options offer you very good protection against falling stock markets. A purchase is recommended. Of course, you can also buy government bonds from other countries such as Japan, Germany or Brazil through TD Ameritrade or other professional brokers. The possibilities are almost unlimited. And regionally distributed government bonds naturally also offer a diversification bonus.

General Diversification Advice

Diversify by investing more diversely. You can achieve this, for instance:

• Companies from different regions
• Bonds instead of shares
• Spread the portfolio across small/medium/large companies
• Different sectors (e.g. do not put everything into tech stocks, even if these are currently in high demand)
• Exchange trade funds, e.g. also via indices (e.g. ticker: SPY)

Short Selling

Short Selling is not a thing I prefer or like. This is my personal opinion and more of an ethical discussion, but let’s put that aside for this.

To “short” means to sell short, i.e. you are betting on falling prices. Personally, I don’t like the idea, and I’m not alone. But it is simply undisputed that people can make a lot of money with it.

To be able to sell short, your account must fulfill special conditions, which you should ask your broker/bank about. These include a minimum amount of cash, proof of experience, etc.

However, you can simulate shorting with an ordinary trading account. If you are eligible for options, you can buy put options. However, this also usually requires a higher account level. To get around this, you can buy so-called short ETFs. These behave inversely to their underlying assets. There are different variants that influence the leverage. These often have the designation Ultra in their name or the designation 1x, 2x or 3x. An ETF with the designation 3x has 3x leverage.

The best-known short ETFs are (and also have) very high liquidity. Due to the high liquidity, the spreads are small, i.e. the difference between buying/selling. We are all familiar with large spreads when buying/selling foreign currencies at the bank):

• ProShares Short S&P 500 (1x leverage, underlying S&P Index), ticker: SH
• ProShares UltraShort S&P 500 (2x leverage, underlying S&P Index), ticker: SDS
• Direxion Daily S&P 500 Bear 3X Shares (3x leverage, underlying S&P Index), ticker: SPXS
• ProShares Short QQQ (1x leverage, based on Nasdaq 100 stocks), ticker: PSQ
• ProShares UltraShort QQQ (as above, but 2x leverage), Ticker: QID
• ProShares UltraShort Oil & Gas (2x leverage), Ticker: DUG
• ProShares UltraPro Short Dow30 (3x leverage, underlying DowJones-30), ticker: SDOW
• Direxion Daily Gold Miners Bear 2x Shares (2x leverage on gold mining companies), ticker: DUST
• iPath S&P500 VIX Short-Term Futures (1x leverage with underlying volatility index VIX), ticker: VXX

So if an underlying asset falls, the values of these short ETFs rise depending on the leverage. You can see for yourself that large profits can be made quickly, especially with triple leverage, but also large losses. Think carefully about this strategy, but it can actually protect you if shares fall. In a bull market, these ETFs will of course reduce your remaining equity gains.

So think about how much you want to invest in these short ETFs. Calculate your equity portfolio and take a percentage that you think is appropriate for shorting. It certainly makes no sense to invest the same amount in short ETFs for shares worth US$ 50,000. This is all about defensive investing, and it is only intended to protect against excessive losses in the event of a stock market crash.

Defensive Stocks/Industries

Every industry behaves differently in the economic cycle. This is reflected in the fact that some companies perform strongly at the beginning of an upswing, but tend to stagnate during the economic boom and quickly decline when an economic downturn looms. This means that every company has its peak during the cycle, which can of course extend over months and years depending on the nature and duration of the economic cycle, be it a recession or a boom.

Which industries or sectors are considered defensive and are relatively stable in value during downturns?

These include companies that produce, for example, everyday food, but also other goods that are always needed, regardless of the current economic cycle. Examples of such companies are Coca-Cola (ticker: KO), Procter & Gamble (ticker: PG), Colgate-Palmolive (ticker: CL), Unilever (ticker: UN resp. UL), Kraft Heinz (ticker: KHC), Tyson Foods (ticker: TSN), Philip Morris (ticker: PM), Walmart (ticker: WMT), Target (ticker: TGT), Dollar General (ticker: DG), General Mills (ticker: GIS), Costco (ticker: COST) and Constellation Brands (ticker: STZ).

This includes defensive stocks with some very good dividend yields. Electricity, water, gas etc. are also needed in times of crisis, even if industrial companies, office buildings etc. naturally draw less electricity as a result of an economic crisis. Nevertheless, the decline will not be so dramatic as to cause these heavyweights undue concern. Moreover, most of them have very solid balance sheets and can adapt their sometimes capital-intensive operations to the difficult conditions by reducing their capex (capital expenditure).

Examples of such companies are NextEra Energy (ticker: NEE), Avangrid (ticker: AGR), Dominion Energy (ticker: D), Duke Energy (ticker: DUK), XEL Energy (ticker: XEL), Hawaiian Electric (ticker: HE), Southern Company (ticker: SO), First Energy (ticker: FE), American Water Works (ticker: AWK), Fortis (ticker: FTS), Brookfield Infrastructure Partners (ticker: BIP) and National Grid (ticker: NG)

Companies in the healthcare sector are relatively resistant to economic cycles and stable in value. However, a good analysis is also essential here, as not every company has the same prerequisites for surviving an economic downturn. It is therefore worth studying the business figures more closely before investing.

Interesting companies here are: Bristol Meyers Squibb (ticker: BMY), Abbott (ticker: ABT), CVS Health (ticker: CVS -> watch out for debt load), AbbVie (ticker: ABBV), Merck (ticker: MRK), AstraZeneca (ticker: AZN), Sanofi (ticker: SNY), United Health (ticker: UNH), Anthem (ticker: ANTM), Medtronic (ticker: MDT), Intuitive Surgical (ticker: ISRG), Johnson & Johnson (ticker: JNJ), Novartis (ticker: NVS), Glaxo Smith Kline (ticker: GSK), Axsome Therapeutics (ticker: AXSM), Boston Scientfic (ticker: BSX), Amgen (ticker: AMGN) and Stryker (ticker: SYK).

Please note that there are also excellent exchange traded funds (ETFs) for all of these sectors.

It is also important to realize that in general, a Democratic U.S. president is more likely to hurt the healthcare sector, as many Democrats have long been pushing for a reduction in skyrocketing healthcare costs (but Donald Trump wants to do the same). This conflict will definitely come to a head in the future, which is something to keep in mind before investing.

Surprise bags

Well, what does that mean? Depending on the type of stock market or economic turbulence, miracle bags can be very good defensive stocks. What do we mean by that?

If, for example, geopolitical tensions, wars (supra-regional) or similar acts of warlike terrorism take place on a large scale over a longer period of time, defensive stocks are of course worth their weight in gold in the truest sense of the word. And by this we simply mean weapons manufacturers such as Lockheed Martin (ticker: LMT), General Dynamics (ticker: GD), Transdigm (ticker: TDG) or Raytheon (ticker: RTX).
However, if the downturn is economic, it is quite possible that the defense budget will be slashed (very likely with a Democrat as US president). Then, of course, such companies will suddenly no longer be so much in demand.

In principle, crime also increases when there are economic problems. In the USA in particular, this leads to outright hoard purchases of firearms. Even if such companies are not suitable for everyone, they are mentioned here. The best known are American Outdoor Brands (ticker: AOBC), Sturm, Ruger & Company (ticker: RGR) or Vista Outdoor (ticker: VSTO).

Infrastructure companies, e.g. road construction, are another possibility. However, these could also suffer in the event of an economic downturn and tight budgets, so caution is advised here. Nevertheless, such stocks are likely to hold up better than aggressive stocks such as tech companies or banks, which could also suffer severe losses in a recession. Well-known stocks in the infrastructure sector are Martin Marietta Materials (ticker: MLM) or Vulcan Materials (ticker: VMC).

Cryptocurrency

I am only listing Bitcoin and similar currencies such as Ethereum for the sake of completeness. Nevertheless, Bitcoin and other cryptocurrencies have gained enormously in importance and are ubiquitous.
There are professionals who claim that bitcoins would be a very good investment in a recession. However, since bitcoins have never been through a real recession, it is completely unknown how digital currencies will behave in the event of a stock market or economic crash. It is quite possible that they will skyrocket, but the opposite could also be the case. There are many arguments for both sides, but most arguments are just conjecture and unproven assertions without any real facts. Digital currencies are more a matter of faith, almost a religion, and therefore, like real religions, often irrational. Expect the unexpected!

You can invest a small portion of your money in digital currencies and then hope that your plan works out, but don’t take too big a chance, and as I said, you have been warned. It can also backfire big time.

Last but not least – preferred stock

Preferred shares are a mixture of shares and bonds. By no means every publicly listed company with shares also offers preferred shares.

Preferred shares often offer a higher dividend than ordinary shares. In addition, holders of preferred shares are paid out before holders of ordinary shares in the event of liquidation of the company and therefore enjoy this preferential treatment. However, they still rank behind creditors and bondholders, so the security is far from bombproof.

If the preferred shares are issued, clear rules are set for you depending on the company, which you should be able to see on any company website under “Investor Relations”. The dividend can depend on various factors and vary, there are conversion rights into normal shares (e.g. when the share price reaches a certain value), or voting rights are revoked.

So apart from the normally higher dividend, what is the reason for buying preference shares?
Well, preference shares are much more stable in price. However, this also means that you almost completely give up the potential price gains of ordinary shares (even if not completely), but are more immune to price falls.

However, you should read the conditions of the preference shares carefully, the devil is in the detail. Some companies (especially smaller ones) create a false sense of security with these shares. I do not recommend preferred shares of companies with a market capitalization (market value) of less than US$ 100 million. Absolutely exaggerated dividends are also a warning sign.

These shares are normally traded on the stock exchange, but the volumes are significantly lower as there are far fewer preference shares in circulation. If only a volume of US$ 10,000 is traded daily, the liquidity is very low and you could have problems selling the shares you have bought. In addition, the difference between the buy/sell price is likely to be very high when liquidity is low, which will cost you money directly. Here, too, I would recommend staying away if the daily volume is less than US$ 100,000.

However, if you have checked the above factors and have a good feeling, preferred shares can be a good option for generating income with reduced risk, and you could invest a few percent of your portfolio in this way.

Conclusion

I think all those options for investing give you an excellent overview on how you can protect yourself from market volatility. Don’t ever get too invested in a single category (like tech heavyweights). Yes, if everything goes well, you can make a lot of money. But if not, you’re in deep trouble and will have many sleepless nights. Always count in the risk/reward equation. Investing/trading is not a gambling, always keep that in mind!