It’s been a heck of a ride for equities over the last few years. After bottoming out during the Great Recession and credit crisis, stocks have climbed to lofty heights. Ignoring a few dips along the way, the S&P 500 — as represented by the SPDR S&P 500 (SPY) — is up over 113% over the last five years. Likewise, the Dow Jones Industrial Average and Nasdaq index have all recently flirted with new highs. All in all, it's been a great time to own stocks.

And that has many investors and market-watchers wary.

After such a torrid surge upwards, it’s getting harder to please investors. Cracks are starting to form and predictions of a bear market are starting to be made. For investors, the continued rise amid concerns of a correction could be the signal to start looking at getting defensive. (For related reading, see: Connecting Crashes, Corrections and Capitulation.)

Trouble Brewing?

First, when looking strictly at metrics, stocks are getting a tad expensive. The S&P 500’s current P/E of around 18 is well above historic norms of around 15. At the time same time, economist Robert Shiller’s cyclically-adjusted price-to-earnings ratio – or CAPE ratio – is insanely high. Unlike the standard P/E, which looks at earnings of one year, CAPE looks at average profits over the last ten years. Historically, the CAPE of the market is around 16. Today that number is 26.3. Essentially, that means that stocks are around 40% overvalued than their traditional historic averages.

Those earnings haven’t exactly been very robust, though. A variety of companies that have recently released earning reports have either missed expectations or relied on cost cutting measures rather than revenue growth to bolster their results.

Another poor sign for stocks are the recent stumbles seen in the housing market. Recent data show that housing starts plunged 9.3% and new building permits tumbled 4.2% last month. Meanwhile, new home sales nationwide fell by 8.1% in June. Considering how important housing is to the economy, none of these data figures are encouraging. (For more, see: Understanding The Case-Shiller Housing Index.)

Adding in the recent global issues in Europe and key emerging markets like China, and the various threats of war across the global, and that correction could be here sooner rather than later.

Time To Get Defensive

Wary investors should examine more “defensive” investments. While the ride could continue, stocks could also go sideways. Luckily, there are plenty of ways for regular retail investors to position themselves for the potential strife ahead. A prime way is through the Guggenheim Defensive Equity ETF (DEF). (For more, see: What Are Defensive Stocks.)

With “defense” in its name, DEF focuses on stocks with low valuations, conservative accounting and a track record of outperformance during sliding markets. Currently, the ETF tracks 101 different stocks, including “boring” names like waste management company Republic Services, Inc. (RSG) and pipeline firm Energy Transfer Equity LP (ETE). That focus on defensive sectors and dividends has allowed the ETF to hold its own during markets downturns. DEF lost less than the overall market during the major panic in 2008-2009. And if the markets drift sideways, DEF should be able to withstand any bumps. (For more, see: Guard Your Portfolio With Defensive Stocks.)

Also on a more defensive stance are the so-called low-volatility funds. The iShares MSCI USA Minimum Volatility (USMV) and the PowerShares S&P International Developed Low Volatility (IDLV) bet on stocks that tend to move within a narrow range compared to their respective indexes. Such funds smooth the ride for investors, though some upside is likely to be sacrificed. (For more, see: How To Day Trade Volatility ETFs.)

However, low volatility or defensive equity funds may not protect your portfolio if a widespread correction happens. To that end, moving some of your holdings into dedicated short funds may be in order. The ProShares Short S&P 500 ETF (SH) allows you bet against the benchmark index and its extremely high CAPE ratio, while the actively managed AdvisorShares Ranger Equity Bear ETF (HDGE) uses a variety of screens to create its portfolio of overvalued stocks ready to fall. Both funds have performed quite badly in the upwards trending market, they have managed to capture the downside during any recent hiccups. Both HDGE & SH could be great ways to protect your portfolio.

The Bottom Line

While it hasn’t happened yet, signs are pointing to the fact that stocks are a bit frothy and a major correction could be near. For investors, getting a bit more defensive could make sense.

Related Articles
  1. Investing News

    Learn How To Invest Defensively From This Hedge Fund Pro

    With the Dow Jones Industrial Average and the S&P 500 hovering near all-time highs and plenty of investors shifting to a defensive stance, there are plenty of opportunities to bet against the ...
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  4. Mutual Funds & ETFs

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
  5. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  7. Insurance

    Whole or Term Life Insurance: Which Is Better?

    Learn the difference between term life insurance and whole life insurance. Understand when it is beneficial to buy each type of life insurance.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares 10-20 Year Treasury Bond

    Learn about the iShares 1-20 Year Treasury Bond ETF and its holdings, and understand why investors may be better served to look at other bond funds.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares Global Telecom

    Learn about the iShares Global Telecom exchange-traded fund, which invests in U.S. and foreign telecommunication companies with high dividend yields.
  10. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  4. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  5. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  6. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>
  3. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!