Put Defensives in Perspective

Can't sit out a tough market? Focus on strength. Just be sure you know how strong that strength is.
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This column was originally published on RealMoney on July 26 at 3:00 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

I have suggested a very defensive market position with high levels of cash for several months now. It's better to sit and wait for good buying opportunities to come to you rather than forcing trades just for the sake of being active. Preserve your war chest for those great market opportunities that appear only a few times a year.

Unfortunately, most of us aren't that patient. But if you've been raising cash on rallies, you're probably more


of this market, and will be more clear-headed when opportunities present themselves so you can strike well.

Right now, traders and investors who feel compelled to be active will find those opportunities in the strongest areas of the market: utilities, consumer staples, large value and pharmaceuticals. If you are going to be active in a negative market, you should focus on areas that are holding up or performing well rather than riskier bets.

Defensive issues are the current areas of strength. These sectors behave very predictably when professional investors think there is a possible slowdown in the economy. Institutional investors such as mutual fund managers move the market, and when they need to get defensive, they move to certain sectors of the market. They are mandated to have a majority of their assets fully invested, so they have to go somewhere.

That's going to be the assets they perceive to have the least risk: low-growth areas. Institutions move away of more risky areas like small caps, technology and emerging markets and ride out the storm in larger, liquid names that have steady earnings for protection.

The charts below show some of the current areas of strength in the market.

The Dow Jones Utilities Average is hitting new nine-month highs, but I'd be leery of jumping into them now. These defensive stocks do better when the market is weak, and many income investors use utilities for income because they often pay more than bonds. Strength in this group is also another sign of a slowing economy.

Currently, the Dow Utilities Average is near the resistance of the September 2005 high. Another concern is that the assets that have been going into the


utilities fund have gone up from $10 million a few months ago to nearly $100 million this week. I don't like investing in a sector after everyone has jumped in, and a rise in assets like this could be a warning signal. Assets were this high on Sept. 19, 2000; Feb. 16, 2001; and July 11, 2005. Those were all good times to avoid the utilities sector.

Consumer staples also are a hiding place for institutional money when the economy slows. As this chart of the

Consumer Staples Spyder

(XLP) - Get Report

shows, this is certainly the case here as they break to four-year highs. There is some resistance around $26, and I would expect some consolidation in that area.

I have been saying that the small-caps were in a topping process and that the next logical place of rotation could be the large-cap value stocks. Institutional investors use large liquid stocks for a defensive position when they take profits from riskier assets. You can clearly see the strong performance of the

Morningstar Large Value Index fund

(JKF) - Get Report

as it sprints to new highs while the general market lags.

The pharmaceuticals have started to perform very well lately. You can see from the chart of the

Pharmaceutical HOLDRs

(PPH) - Get Report

that they have broken above resistance. These stocks have been lagging the market for a long time, and may be due for their time in the sun.

I'd also like to clear up some confusion about my reference to the moving-average crossover I referred to on Monday vs. other comments on


about the significance of these crossovers.

Technicians have seen the significance of moving-average crossovers for centuries, and they can be significant when they occur with short-term, intermediate-term or long-term moving averages. Some traders use them as signals to enter or exit a market (I don't).

The signal is given when the shorter-term (faster) moving average crosses, up or down, through the longer-term (slower) moving average, such as the 10-day moving average crossing through the 30-day moving average.

The cross is most significant if both averages are pointing down when the crossover takes place. However, when using a longer-term moving average like the 50-day crossing through the 200-day, it doesn't pay to wait for the 200-day to enter a downtrend. It's so much slower than the 50-day, you'd either never get the signal or it would come too late to be useful. The charts of the


and Semiconductor index (SOX) show that if you waited for the 200-day MA to decline, you would have had significant losers with no signal.

What's most important to know about crosses: not to get caught up in indicators of any kind. Use them only to confirm or discern divergence of price and volume movements. For months I have warned investors to be cautious and raise cash; had I waited for one of these crossovers, I wouldn't have avoided much of the carnage that has happened.

As an investor, you need to do your own research and develop your own style based on what works for you. All of the columnists on


are excellent in their chosen disciplines, and each will interpret things differently. That is why you, as the investor, should use us as guides, not gurus.

At time of publication, Manning had no positions in the stocks mentioned, although holdings can change at any time. Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.