Best Defensive Stocks With Low Correlation to SPY

The S&P 500 index is regarded as the barometer of U.S. stock market performance. Composed of 502 large-cap U.S. equities, the S&P 500 index is often used as a benchmark for professional and retail investors alike to compete against. When it comes to funds, the SPDR S&P 500 ETF (NYSEARCA: SPY) is the largest and most liquid exchange-traded fund (ETF) for tracking the S&P 500.  Here are the best defensive stocks with low correlation to SPY.

• Procter & Gamble Co
• Merck & Co Inc
• Bristol-Myers Squibb Co
• American Tower Corp
• General Mills Inc
• McDonald’s

One investment strategy with the potential to outperform over long periods is buying stocks that have a low correlation to SPY. This metric is primarily measured by the stock’s beta, which also incorporates measures of the stock’s volatility. The market (in this case, the S&P 500 or SPY) always has a beta of 1.0, while stocks can have a beta of:

1. Above 1.0, meaning that the stock generally moves in the same direction as the market and in a more volatile fashion.
2. Below 1.0 but higher than 0.0, meaning that the stock generally moves in the same direction as the market but in a less volatile manner.
3. At 0.0, meaning that the stock generally moves in a way uncorrelated to the movements of the market. 
4. Below 0.0, meaning that the stock moves inversely to the market, and in a more volatile fashion as it gets more negative. 

The following defensive stocks all have a low correlation (beta of 0.50 or under) compared to the SPY. In addition, these stocks exhibit sound fundamentals in the form of positive return on equity; return on assets; return on investment; and gross, operating, and net margins. They also have positive historical earnings and revenue growth. A combination of quality characteristics plus a lower-than-average beta makes these stocks potential defensive picks. 

Procter & Gamble Co. (NYSE: PG)

With a market capitalization of $330 billion, PG is one of the largest consumer defensive companies in the world. The company provides an array of essential products to consumers worldwide via five segments: beauty; grooming; health care; fabric and home care; and baby, feminine and family Care. PG has achieved a strong network effect through its robust distribution network consisting of mass merchandisers, e-commerce, grocery stores, membership club stores, drug stores, department stores, distributors, wholesalers, specialty beauty stores and pharmacies. Currently, the company has a five-year monthly beta of just 0.34, making it a third as volatile as the overall market. Since 1993, PG has outperformed the SPY with a compound annual growth rate (CAGR) of 10.95% compared to 9.72% with all dividends reinvested.  

Merck & Co. Inc. (NYSE: MRK)

MRK is a healthcare company operating through two main segments: pharmaceuticals and animal care. For the former, MRK offers various human pharmaceutical products related to oncology, immunology, neuroscience, virology, cardiovascular and diabetes. For the latter, MRK discovers, develops, manufactures and markets veterinary pharmaceuticals, vaccines and health management services such as identification and tracking devices. Worldwide, MRK collaborates with other healthcare companies to develop and commercialize vital medications, including HIV/AIDS treatments. Currently, the company has a five-year monthly beta of just 0.34, making it a third as volatile as the overall market. Since 1993, PG has underperformed the SPY with a CAGR of 9.54% compared to 9.72% with all dividends reinvested.  

BMY is another long-standing healthcare company known for developing, licensing, manufacturing and marketing various pharmaceutical products. Notable examples include its cancer treatments, which treat everything from lymphoma, myeloma and leukemia. The company sells products not only to wholesalers but also directly to pharmacies, hospitals, clinics and government agencies. Currently, the company has a five-year monthly beta of just 0.45, making it slightly less than half as volatile compared to the overall market. Since 1993, PG has underperformed the SPY with a CAGR of 9.44% compared to 9.72% with all dividends reinvested.  

AMT is one of the largest North American-based Real Estate Investment Trusts (REITs). The company boasts a portfolio of around 219,000 cellular communications sites, from which it gains lease income tied to the performance and growth of the communications sector. Its major lessees include AT&T Inc. (NYSE: T) and T-Mobile US Inc. (NASDAQ: TMUS). Despite falling hard during the 2000 dot-com bubble, the company has rallied strongly in recent years thanks to the 5G boom. Currently, the company has a five-year monthly beta of 0.49, making it around half as volatile compared to the overall market. Since 1999, PG has outperformed the SPY with a CAGR of 10.43% compared to 6.95% with all dividends reinvested.  

GIS was incorporated in 1928 as a flour miller. Over the century, the company has expanded to become one of the largest suppliers of cereals and pre-packaged foods worldwide. GIS is known for its large selection of products, with famous brands such as Fruit Gushers, Cinnamon Toast Crunch, Cocoa Puffs, Nature Valley, Pillsbury, Yoplait, Wheaties and Cheerios being pantry staples across America. The company distributes products via a robust network of grocery stores, mass merchandisers, membership stores, natural food chains, e-commerce, convenience stores, pharmacies and discount retailers. Currently, the company has a five-year monthly beta of just 0.32, making it a third as volatile as the overall market. Since 1993, PG has outperformed the SPY with a CAGR of 9.81% compared to 9.72% with all dividends reinvested.  

Founded in 1940 and headquartered in Chicago, Illinois, McDonald’s Corporation operates and franchises McDonald’s restaurants in the United States and internationally, where the company offers hamburgers and cheeseburgers, chicken sandwiches and nuggets, fries, salads, shakes, frozen desserts, sundaes, soft serve cones, bakery items, soft drinks, coffee and beverages. There’s also a breakfast menu, including muffins, Sausages, biscuit and bagel sandwiches, oatmeal, hash browns, breakfast burritos and hotcakes.

Investing in low-correlation stocks can be a good way to insulate your portfolio from the broader market’s movements. For investors with lower risk tolerance, investing in low-correlation stocks can help reduce volatility and ensure a more consistent sequence of returns. It can also help reduce drawdowns, which is how large a peak-to-trough loss is for an investment portfolio. 

Benefit: Lower market risk

Market risk is the risk that volatility in the broader stock market can affect the value of your investments. Market risk is unavoidable unless you only hold cash, but it can be mitigated by holding stocks with a low correlation to SPY. For example, while the S&P 500 lost over 16% so far in 2022 due to inflation and rising interest rates, all the stocks mentioned earlier (except for AMT) have returned positive so far thanks to their lower beta. During the 2020 COVID-19 crash, most of these stocks plunged less too, albeit still more than bonds. 

Benefit: Lower volatility

Low beta stocks tend to also have a lower standard deviation. This is the amount that a stock has historically moved around its average. For example, a stock that has returned 10% over the last decade with a standard deviation of 20% has fluctuated in value between -10% to 30% at times. Keeping standard deviation low by picking low-beta stocks can help your investment compound at a steadier rate without the violent ups and downs. Over the long term, keeping unrealized losses minimized can play an important role in increasing total returns. To illustrate this, consider how a 33% loss from $100 to $66.66 requires a subsequent 50% gain of $33.33 to break even again. 

Benefit: Better portfolio risk-adjusted returns

Modern Portfolio Theory states that a portfolio of uncorrelated assets with positive expected returns can produce more return for less risk compared to a single asset. Incorporating low-correlation stocks into a diversified portfolio of stocks, bonds, cash and alternatives can help investors optimize their risk-adjusted returns further by dampening volatility without sacrificing performance. Often, adding low stocks with a low correlation to SPY or the broad market can increase a portfolio’s Sharpe ratio, a measure of risk-adjusted returns. 

Defensive stocks are those with traits that help them endure during difficult economic or market conditions. Often, this translates into a competitive business advantage that ensures their margins, revenue and earnings stay healthy. Often, defensive stocks are found in the consumer staples and healthcare industries because of their evergreen demand and essential nature. Investing in these stocks can be desirable for investors with a lower risk tolerance or shorter time horizon. 

Benefit: Counter-cyclical performance

Defensive sectors like healthcare and consumer staples tend to lag during low-interest rate bull markets but can strongly outperform during times of high inflation or rising interest rates. Case in point, GIS, MRK, BMY and PG all returned positive in 2022 (as of September) despite the broader market being in the red. Of these stocks, both MRK and BMY are healthcare sector companies, while GIS and PG are consumer staples. As mentioned earlier, the evergreen demand and essential nature of these companies help ensure their revenues, earnings and margins stay relatively intact during times of economic stress. 

Investors looking for higher-than-average income might like defensive stocks. Because defensive stocks are often those of mature, blue-chip companies, they tend to have surplus cash reserves that they pay out quarterly to investors as a dividend. Often, the dividend yields from these companies exceed the average offered by SPY. Dividends from U.S. companies are generally taxed at a more favorable rate, making them tax efficient. Reinvesting these dividends plays an important role in compounding total returns more. 

Benefit: Psychological ease

Prolonged bear markets are difficult to endure for even experienced investors. Having some stocks that remain in the green while the overall market is in the red can be a much-needed psychological boost for investors. Investors who need to withdraw money from their portfolios for income can sell shares of these companies first to avoid locking in an unrealized loss. This can sometimes mean the difference between staying the course and remaining invested instead of capitulating and panic-selling. 

Investors looking for further insights and reviews of defensive low-correlation stocks can use Benzinga to compare the available options. Here is also a list of brokers where you can invest in defensive stocks.