After trading to historic highs, the market has started to show some signs of weakness. The biggest cloud hanging over the stocks at this time is fear about future interest rate increases.
Last December, the Federal Reserve lifted interest rates for the first time since the financial crisis, and the market expected additional rate hikes this year. So far, we have not seen additional increases, but some Fed officials have recently started hinting that another rate hike will come before the end of the year.
Low interest rates have definitely helped keep strength in the overall market. The primary reason higher rates would have a negative impact on the market is some money would flow out of the markets and back into traditional fixed income assets once yields inch higher.
Of course, the obvious unknown is just how much money would flow out of the market. There will be some money flow, but there is also a case to be made that higher rates signal future strength for the economy.
The reason for this is that the Federal Reserve, which has kept rates low in order to boost the overall economy, would not make a move after so long to lift rates unless it felt strongly that the market and the overall economy was ready for such a move. If the Fed is right, and economic conditions are strong enough to warrant an interest rate increase, that suggests a bullish outlook for stocks.
While I believe a rate increase suggests a bullish long-term outlook for the overall market, I acknowledge that there will be, at the very least, a little short-term volatility. One way to avoid that volatility would be to liquidate your portfolio and sit on the sidelines until the dust clears. A better way to approach the situation is to keep your money at work, but identify stocks that have the best chance of avoiding a major sell off.
In order to best insulate your money from a potential sell off would be to find socks that are most closely tracking the overall market. We can do this by looking at a stock’s correlation to the overall market.
We are going to run a correlation analysis using the Dow Jones’ 50-day moving average. Correlation ranges from +1.0 and -1.0. The closer the correlation is to +1.0, the more closely the stock is tracking the overall market.
Each of the following stocks closely tracked the overall market in recent months, and should serve as defensive plays versus a potential market dip.