By its very nature, stock market investing is both volatile and risky. While investors want their holdings all to grow, market turbulence can quickly throw plans off course and it is for this eventuality that many turn to defensive stocks to provide an element of protection.
Since the global financial crisis in 2008-09, stock markets have enjoyed more than a decade-long bull market, with growth stocks producing huge returns. However good things can’t always last and in the event of a downturn, like the one seen at the outset of Covid last year, these same stocks may be more susceptible.
In circumstances such as this, defensive stocks – namely companies that sell vital goods and services, have reliable earnings and, where possible, pay dividends – tend to hold their value better.
Not to be confused with defence stocks, which are the stocks of companies that manufacture things like weapons, ammunition, and fighter jets, defensive stocks tend to be more stable through a market cycle because there is constant demand for the business’ goods and services. The caveat with being lower risk, is that during bull markets, returns can often lag higher growth peers.
Given that they don’t rely on the timing of the market cycle for growth, defensive stocks are also known as non-cyclical stocks, and they can be found in multiple sectors of the market. The main areas are Utilities (water, electric, gas and broadband suppliers), Consumer Staples and Healthcare. In all market conditions, people need to go to the shops and buy staples such as food, drinks and tobacco, while the need for healthcare and pharmaceuticals also does not subside, as people will always be sick and in need of care.
Additionally, many investors now also consider areas of technology essential spending, meaning you could therefore assume these will be the new classic defensive sectors of the future.
We have some great defensive companies here in the UK. If you’re not familiar with the companies, you’ll probably be familiar with some of the brands that they own, which we’ll detail more below.
Diageo is one of the names you might not be familiar with, but you’ll certainly be familiar with some of its underlying brands – including Guinness, Smirnoff, Bailey’s, Pimm’s and Tanqueray, among many others.
It is listed on both the London Stock Exchange and the New York Stock Exchange and is part of the FTSE 100.
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If you’ve recently had one of your coronavirus vaccines, whether it’s a first dose, a second dose or a booster shot, you may have had the AstraZeneca coronavirus vaccine. For a lot of people, this was the first time they’d heard of this company, but it’s a longstanding company with a history dating back more than a century. AstraZeneca has products used to help diseases in oncology, the cardiovascular system, the gastrointestinal system, neuroscience and the respiratory system.
The stock is listed on the London Stock Exchange, NASDAQ OMX Stockholm, NASDAQ New York, the Bombay Stock Exchange and the National Stock Exchange of India. AstraZeneca is part of the FTSE 100 index.
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DAt the opposite end of the health scale to Astrazeneca sits British American Tobacco (BAT). BAT has long been a popular UK defensive stock and it has been one of the highest yielding stocks on the FTSE 100 for years, as the addictive nature of nicotine means demand for its products stays stable regardless of the economic situation. Of course, there’s an ethical factor when it comes to investing, and some may be uncomfortable including the stock in their portfolios.
BAT sits in the FTSE 100 and its primary listing is on the London Stock Exchange. It has secondary listings on the New York Stock Exchange and the Johannesburg Stock Exchange.
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There are defensive companies all over the world, so you don’t have to stick with stocks closer to home if you don’t want to. Investing in some global stocks means that you can diversify your portfolio, but you can also encounter foreign exchange fees and fluctuations.
One of the largest stocks in the S&P 500, Microsoft is a household name. The hardware and software company is best known for its Windows operating system, the Microsoft Office suite of programs, and the Xbox game system. The company also is a major player in cloud computing services, with its cloud platform, Azure.
Microsoft is listed on the NASDAQ and is a component of the NASDAQ-100, S&P 100, S&P 500 and Dow Jones Industrial Average.
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Measured by its revenue and other metrics, Nestle is currently the largest food company in the world. Based in Switzerland, the multinational food and drinks conglomerate was founded in 1866 by Henri Nestlé and its product portfolio includes brands such as Nespresso, Smarties, Kit Kat, Stouffer’s, and Nesquik. A company with over $95bn in sales, the consumer staple has constantly risen its dividend over the last decade.
Nestle is listed on the SIX Swiss Exchange.
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Owning several of the world’s best-known high-end brands in jewellery, spirits, fashion, and more, Moet Hennessy Louis Vuitton (LVMH) fits the bill when it comes to a true recession proof stock. High-end luxury companies like LVMH generally thrive during market downturns because their more affluent customers struggle less during economic downturns.
LVMH is listed on the Euronext Paris Eurolist.
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Over time defensive stocks have been able to deliver similar long-term gains – with lower levels of risk – than the broader market. However, there could be long periods of underperformance when the style is out of favour. Allocations to defensive stocks are typically made when investors are looking to protect portfolios when the economy is showing signs of weakness or the stock market is experiencing elevated levels of volatility.
At the same time, defensive stocks are often well-established companies, with a long history of stock market earnings and dividends. As a result, so they are often of interest to dividend investors, or to anyone looking to find long-term gains with lower risk iinvestments.
The caveat, or trade off, of investing in something that protects you in market downturns is that they offer you less prospects for growth when markets are soaring. Unfortunately, many investors abandon defensive stocks out of frustration with underperformance late in a bull market, when they really need them most.
Defensive stocks offer relative price stability, whatever the state of the economy, because they sell goods that we all buy in good times and bad. Classically, they include pharmaceuticals, tobacco and utility companies. It’s no coincidence that in the past, these have been some of the most consistent dividend payers in the UK market. They are, by their nature, consistently reliable.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
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