2019 has been the year of the defensive stock. Gone are high risk bets on growth stocks. Instead, the past 12 months have seen traders pile into so-called defensive stocks in tried and tested sectors to mitigate risk.
Concerns over the US-China trade war and a slowdown in the US economy have seen traders switching out risky growth stocks. Utilities, real-estate investment trusts and other defensive stocks are now being bought up and outperforming the rest of the market.
This shift has powered the S&P 500 to an all-time high. And it’s a trend that looks set to continue.
The S&P 500's record high, having risen 0.6% to trade above the previous record hit on 26 July
How have defensive stocks performed?
As the Wall Street Journal points out, the S&P 500's retail estate and utility sectors are up 1.3% and 1.9% respectively in the month up to 13 October, while the rest of the index dropped 1%.
Over a 12 month period, the difference is even more pronounced. Data from S&P Dow Jones Indices shows that the S&P 500 utilities sector has delivered a 23.86% return since this time last year. This easily outpaces the wider S&P 500’s 14.44% return and the S&P 500 Growth sector’s 10.7% return.
Defensive stocks often come with healthy dividend payouts. Unlike tech stocks where companies are yet to turn a profit defensive stocks tend to be in large, established businesses. That means that even if the share price doesn’t climb, traders can still get a payout.
For example, US real estate investment trust Prologis’ share price is up almost 33% over the past 12 months, with a robust 2.31% dividend. On the utilities side, NextEra Energy’s share price is up 36.2% over the past 12 months, with a 2.2% dividend yield. Both stocks have seen trading volumes increase over the past month. In comparison, crashing SaaS stocks like Slack and ServiceNow are giving traders pause for thought.
It’s not just defensive stocks that have been gaining traction. Exchange traded funds are seeing increased inflows as investors seek low volatility options. According to Strategas, investment in equity ETFs surpassed $20 billion this year - 20x that of growth stocks.
But how much upside is there? Mike Wilson, chief US equity strategist at Morgan Stanley said:
"During the most recent growth scares in late 2015/early 2016 and 4Q18, the defensive cohort outperformed secular growth by 25%. So far, the outperformance has been around 12%, or about half of what I expect to see before it’s over."
Wilson is also concerned over the risk of recession and Federal Reserve interest rate cuts - a sign the Fed is trying to kick-start the US economy.
"My view remains that the risk in Fed scenarios is weighted towards significantly more cuts because growth is slowing much more than many seem willing to acknowledge, and the risk of a recession has increased materially."
“My view remains that the risk in Fed scenarios is weighted towards significantly more cuts because growth is slowing much more than many seem willing to acknowledge, and the risk of a recession has increased materially.” - Mike Wilson, chief US equity strategist at Morgan Stanley
With the S&P 500 having hit an all-time high and the US and China due to sit down to find a way out of the trade war, market optimism should be rife. Some analysts even predict that the S&P 500 will gain 32% to hit the 4,000 level by the end of the decade. However, traders remain risk averse and don't want to get burnt. Peter Jankovskis, co-chief investment officer at Oakbrook Investments, told Bloomberg:
“People are nervous. They see signs of optimism but they’re also wary that these things have broken down several times already.”
In such an environment, adding defensive stocks to a portfolio could be a sensible way to mitigate against this risk.