Time to Get Defensive: XLU, EXC, PEP, VXX, GLD

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In recent weeks, I have been more bearish on the stock market than I have been in some time – and this is probably evident in my last few articles. To recap my reasoning, here is the bullet list: 1). Analyst and investor sentiment has been close to euphoric levels (Recall Goldman’s “Best Time in a Generation To Buy Stocks” comment); 2). Volatility has been dead, suggesting an overly complacent market; 3). Rising gas prices are going to hurt consumer spending, and are going to crimp corporate margins; 4). Europe is still a mess, and may be worsening; and 5) last, but not least, corporations’ potent growth driver, China, is starting to slow at more meaningful and concerning levels.

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First quarter earnings are coming up quickly, and thus far, we haven’t seen many warnings from companies. This isn’t overly surprising, however, because I feel the greater risk is to Q2 guidance and beyond. Yes, I do believe Q1 earnings could be a minefield with some significant disappointments, but it takes time for higher fuel and energy costs to ripple through the economy. It was only late in Q1 that gas prices really became problematic. Additionally, it stands to reason that management’s sentiment towards Europe and China has dampened some. Europe, for the most part, has been written off by corporations, but China has been such an integral part of companies’ growth that this could be a headwind for guidance.

In recent articles, I have mainly focused on short-side selling opportunities. Given that some people are not comfortable with the notion of shorting, today I wanted to offer some options on the long-side that are more defensive in nature and tend to outperform in down markets.

Utilize the Utilities
While the technology and consumer discretionary sectors have been ripping higher in 2012, the utilities sector has been a dog. The SDPR Select Utilities ETF (NYSE: XLU) is actually down close to 4% on the year.  This underperformance is another indication that investors have fully been in “risk-on” mode thus far in 2012. However, with the possibility that the economic data and corporate guidance looks less rosy in the weeks ahead, investors may gravitate towards this more risk-averse ETF. There was a reason that Fed Chairman Ben Bernanke was so clear in his speech on 3/25 that the door remains open for more easing in the future. The logical explanation for this “surprising” suggestion from Mr. Bernanke is because he still feels the economy isn’t strong enough to stand on its own two feet.

Exel-lent Dividend Yield
If ETFs aren’t your cup-of-tea, one utility stock to consider right now is Exelon Corporation (NYSE: EXC). EXC is involved in electricity generation, generating electricity from nuclear, fossil, hydro, and renewable energy sources. Its stock has been a laggard this year, down roughly 10%. But the stock has formed a support base at the $38-$40 level, and its valuation is quite attractive with a trailing P/E of ~10x. In other words, the downside risks look limited here. Add in a 3.90% dividend yield, and EXC looks even better at these prices.

Thirsting For Yield
Another defensive yield play that looks compelling is Pepsi (NYSE: PEP). Its stock is currently yielding 3.10%, not too shabby for this consumer staple company. The company is also planning on bumping up its share repurchase program by at least $3 billion this year, also boosting its shareholder yield. PEP is going through some major restructuring, clouding its fundamental picture. Also, the stock is approaching a key resistance level at $66.50-$67.00. But, from a longer term, “investment” basis, PEP is a stock worth considering.

Plan For Volatility
Following the Greek bail-out this past winter, there was a sense of relief among investors. The risk of default was off the table, and the periphery countries weren’t about to go up in flames either. Along with this sense of relief came a major dose of complacency. But, as I have contended previously, the root of the problem is one of growth – or, lack thereof. Without any economic growth, Greece, and any other country facing these debt issues, will greatly struggle to make good on its payments. The agreements put in place by the ECB make growth assumptions that are at best, optimistic, and at worse, wildly unrealistic. So, it stands to reason that somewhere down the line, we will once again by fixated on another debt crisis in Europe.

There are ways to protect yourself, and even profit, from this expected increase in volatility. For instance, the iPath S&P 500 VIX ETF (NYSE: VXX) is looking especially intriguing at the moment. The VXX just traded to all-time lows on March 26, but has perked up a bit over the past two days. With it still trading at very low prices, and with the probability that headline risk will pick up in the coming months, the VXX should be considered. We would point out, though, that there is some notable resistance at the $24/share level.

Of course, another way to hedge against volatility and heightened risk is to buy gold and precious metals. The SPDR Gold Fund (NYSE: GLD) is looking even more enticing following Mr. Bernanke’s commentary on the monetary policy. The continued usage of QE should weaken the dollar, while also creating more inflation risk in the future – a recipe for higher gold prices.