Yahoo Finance Defensive stocks and strategies to get you through a downturn
Consumer staples and utilities typically include companies with solid dividends and stable demand
As concerns about a potential economic recession weigh on investors, many have opted to undertake defensive strategies as they await the impact of higher interest rates.
While today's macroeconomic environment – featuring stubborn inflation, rapidly rising interest rates and high unemployment – may differ from previous decades, many investment portfolio managers say traditional defensive strategies are still solid options for investors.
"With banks likely to become increasingly conservative (aka tightening financial conditions), the risk of a slowdown has certainly risen... The economy will very likely slow, either a lot or a little. And markets do not appear to be priced for either scenario," Purpose Investments' chief market strategist Craig Basinger wrote in a report to clients recently.
"We believe investors should continue to tilt their portfolios towards the defensive side of their long-term strategic allocation."
Basinger said in an interview with Yahoo Finance Canada that there are many ways investors can play defence in a period of economic uncertainty. One of the most popular trades he has seen so far this year is investors shifting into cash, which now has a more attractive yield for the first time in years.
"There's no denying that the most popular trade year-to-date is cash. Any new money gets parked in cash, and the wall of cash is growing and growing," Basinger said. But he adds that there are "many different ways to be defensive from an asset allocation perspective." For example, Basinger says his fund is currently underweight on equities and overweight on bonds.
"Good old-fashioned bonds with some duration may be one of your best vehicles at this point to provide a balanced portfolio, even though it was completely out of balance last year," he said.
"And you don't want to completely run away from equities, because the market could move higher. It's certainly encouraging to lean more into the defensive side, things like U.S. healthcare, telecommunications and utilities."
Traditionally in recessionary times, investors focus on defensive sectors, although Wellington-Altus Private Counsel managing director Martin Pelletier agrees that cash is "a lot more attractive" than it has been in previous years.
"We're looking at cash that's yielding five per cent, and when you compare that to longer term date bonds, cash looks a lot more attractive," Pelletier said, adding that his investment firm has about 11 per cent of its balanced fund in cash, which is higher than it typically has.
"Parking some of your investments in cash is not going to penalize you as it did a year or two ago when rates were that much lower."
Analyzing interest rate impact
Traditional defensive sectors comprise consumer staples and utilities, areas that typically include companies with solid dividends and stable demand. The S&P/TSX Capped Consumer Staples Index, which includes names like Alimentation Couche-Tard (ATD.TO), Loblaw (L.TO) and Saputo Inc. (SAP.TO), is up 6 per cent this year. The S&P/TSX Capped Utilities Index, which includes companies like Hydro One Ltd. (H.TO) and Northland Power Inc. (NPI.TO), is also up nearly 6 per cent this year.
Anish Chopra, managing director at Portfolio Management Corp., says investing in the traditional defensive sectors such as consumer staples and utilities, areas that tend to have stable demand amid recessionary times, remains a solid defensive strategy. But consumers should pay attention to company cost structure in the wake of rising interest rates.
"As an investor, you can still look at historically defensive areas like consumer staples or utilities, but you have to be more careful about the impact of rising interest rates on their business," Chopra said.
"I think in this case, you have to be mindful as an investor on how much debt is maturing and when is it maturing... You do still have to pay attention to their cost structure, the impact of the new interest rate environment on their business and on the consumer."
Still, some investors have opted not to go with traditional defensive plays. Pelletier notes that many investors have made defensive moves into the 10 largest S&P 500 names, which include technology companies like Apple and Microsoft. Typically in recessions, demand for energy may be curtailed, but Pelletier has maintained and bolstered his fund's position in energy stocks that are still generating strong cash flows.
As for whether now is the best time to pile into defensive stocks, Chopra says it will largely depend on one's macroeconomic view.
"If an investor is concerned about a recession ahead with interest rates staying high for a longer period of time, it certainly makes sense to look at defensive sectors," he said.
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.
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