Investors Seek Refuge in Defensive Stocks Amid Volatile Market

Amid the uncertainty of the stock market in the past year, many investors have sought out reliable investments as a way to protect their money.

This year, stocks of utility, consumer-staples, and healthcare companies have fared better than the majority of the market. Notable examples of this include Consolidated Edison Inc., Campbell Soup Co., and Merck & Co. Inc., all of which have seen double-digit percentage point increases in 2022.

It is commonly believed that certain sectors of the market are more resistant to economic downturns. This is because people still need to pay for utilities, groceries, and medications even when the economy is not doing well. Therefore, these areas are often referred to as defensive sectors.

It is true that defensive stocks have not seen large gains in share prices. However, their minor losses are much better than the 42% and 39% drops in the communication-services and consumer-discretionary sectors, respectively. The only sector that has outperformed defensive stocks in 2022 is energy, which has seen a rally due to geopolitical tensions that have caused oil prices to rise.

As of Wednesday, the S&P 500 utility stocks have decreased by 1.2% in comparison to the beginning of the year, while consumer staples and healthcare stocks have dropped by 3.1% and 4.2%, respectively. The S&P 500 has experienced a more significant decrease of 21%.

In 2022, the S&P 500 utilities and healthcare sectors are outperforming the broad index by the most significant annual margin since 2000. The consumer-staples sector is projected to have the largest lead over the S&P 500 since 2008.

Thomas Martin, senior portfolio manager at Globalt Investments, commented that defensive areas are not particularly thrilling, but they are a good place to take refuge.

The strength of defensive stocks demonstrates the impact of this year's financial conditions on the market. The Federal Reserve's efforts to reduce inflation through higher interest rates has caused investors to prefer stocks that provide immediate returns rather than long-term gains.

Investors have been drawn to defensive stocks for their reliable cash flow. Companies in the S&P 500 utility and consumer-staples sectors have some of the highest dividend yields in the index, with approximately 3% and 2.6%, respectively, according to FactSet. This provides investors with a steady source of income, even when share prices are not performing well.

Lisa Erickson, the leader of the public markets group at U.S. Bank Wealth Management, suggested that clients invest in dividend-oriented stocks this year due to the unsteady market. She believes that the first half of 2023 could still be difficult for investors, so she is continuing to suggest dividend-paying shares as we enter the new year.

She noted that the conditions had been ideal for defensive companies. She added that, with the anticipated volatility, businesses that can offer a greater degree of cash-flow protection in their returns appear to be attractive.

Investors have expressed that defensive stocks appear to be more expensive in comparison to other areas of the market. Wall Street typically uses the ratio of a company's stock price to its earnings to determine if a stock is undervalued or overvalued.

As of Tuesday's close, the S&P 500 consumer-staples sector was trading at an estimated price-to-earnings ratio of 21 for the next 12 months, according to FactSet. The index's utility and healthcare stocks had multiples of 19 and 18, respectively, indicating that defensive stocks may be slightly more overvalued than the S&P 500, which has a price-to-future-earnings ratio of 17.

Chris O'Keefe, the head portfolio manager for Logan Capital Management's dividend-growth strategy, has stated that the company has been reducing its investments in healthcare and consumer-staples stocks as they have become more costly, while increasing its holdings in consumer-discretionary stocks such as Nike Inc. and Starbucks Corp.

Despite the current market conditions, Mr. O'Keefe has maintained a larger portion of his portfolio in healthcare and consumer-staples stocks. He believes these companies will remain successful in the upcoming year as the Federal Reserve continues to increase interest rates.

He stated that companies with more reliable earnings are likely to remain successful even when the market is volatile. He added that these types of companies will always perform well regardless of the economic climate.