Learn to Play "D"

By Sharon Epperson

You could hear investors breathe a sigh of relief last week as stocks seemed to turn the corner. But don't be fooled. The Federal Reserve could still crank up interest rates another notch to make sure inflation is hobbled, and if it does, you won't have to go to the amusement park to get on a roller coaster. Many market strategists are forecasting a choppy ride this summer. But there are ways to keep your portfolio from getting too badly bruised. Rule No. 1: learn how to play good defense.

Begin by making sure your portfolio is diversified. When technology shares hit record highs, diversification became a dirty word. But today, it's a blessing. Your holdings should include a blend of small-, mid- and large-cap stocks, some international equities and bonds.

You may also want to hold some ready cash, say, in a money-market fund. Barry Hyman of Ehrenkranz, King & Nussbaum in New York City sees no problem with investors sitting on the sidelines for a while. He says if you prefer to invest in high-growth stocks, waiting for an opportunity when the market dips may be more attractive than reallocating your investments into safer stocks with moderate gains.

But if you want to stay in the market, defensive investing simply means sticking with stocks that can hold their own or even prosper in a downturn. Start with basic necessities, like food and drugs. Common sense tells you that even in a recession, people still need to eat and fend off illness. Also, while they may not be able to pay their cable or phone bills, they'll need to keep the lights on. So electric-utility companies are viewed as a good defensive group. Tobacco stocks historically have been viewed, ironically enough, as a safe investment, despite the industry's constant litigation.

There have been only four bear markets in the past two decades, and during each the Dow Jones industrial average declined 24% on average. But traditional defensive groups did better than that, according to a survey of 100 industry groups by Florida-based Ned Davis Research. Tobacco was down only 9%. Food producers dipped 12%, and grocery chains fell only 10%. Household-product companies dropped 15%. Drug stocks were off 19%. Electric utilities declined between 5.7% and 8.7%, depending on the region.

Food and drug stocks, in particular, are solid defensive sectors because they are a good value, provide stable profits and are less affected by economic slowdowns. Best Foods shares rose 50% in the past month on rumors of a possible takeover by Unilever. Johnson & Johnson has gained more than 20%, nearly doubling the Dow's gains, in the past three months. Electric utilities, which also pay above-average dividends, have been rallying strongly. The Dow Jones utility average is up nearly 18% since mid-March.

Afraid of missing out on a big run-up in technology? You can still take a defensive posture by staying with market-share leaders--Intel, Oracle, Cisco--rather than the more volatile small- and mid-cap techs.

Don't expect tech-type returns from traditional defensive groups: these stocks are designed to protect your portfolio and are not likely to pump it up significantly. But branching out into these sectors can help you maintain a balanced portfolio, so you're ready to start playing offense again when the market looks a little steadier.

Epperson appears on CNBC Business News between 4 and 7:30 p.m. E.T. daily. Reach her at sharonmoney@yahoo.com