Wall St Week Ahead Investors turn to defensive stocks as economic worries grow

Flags are seen outside the New York Stock Exchange (NYSE) in New York, in New York, U.S., February 24, 2022. REUTERS/Caitlin Ochs/File Photo

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NEW YORK, April 15 (Reuters) – U.S. stock investors are worried about geopolitical uncertainty and the Federal Reserve’s fight against inflation could dampen economic growth and are moving towards defensive sectors they say can better weather turbulent times and tend to deliver strong dividends.

The Healthcare (.SPXHC), Utilities (.SPLRCU), Consumer Staples (.SPLRCS) and Real Estate (.SPLRCR) sectors have seen gains so far in April, although the broader market fell, continuing a trend that has seen them outperform the S&P 500 (.SPX) this year.

Their appeal has been particularly strong in recent months as investors fear the Fed could stifle the US economy by aggressively tightening policy to combat soaring consumer prices. Although growth is currently strong, several major Wall Street banks have raised concerns that the Fed’s aggressive actions could lead to a recession as they work their way through the economy.

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The US Treasury market sent an alarming signal last month, when short-term yields on some maturities of government bonds exceeded longer-term ones. The phenomenon, known as the inverted yield curve, predated past recessions. Meanwhile, fallout from the war in Ukraine remains a concern for investors. Read more

“The reason (defensive stocks) are outperforming is people are seeing all these headwinds to growth,” said Walter Todd, chief investment officer at Greenwood Capital.

While the S&P 500 fell nearly 8% in 2022, utilities gained more than 6%, basic goods soared 2.5%, healthcare fell 1.7% and real estate decreased by 6%.

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As the earnings season kicks into high gear next week, defensive sector companies point to healthcare giant Johnson & Johnson (JNJ.N) and commodities stalwart Procter & Gamble (PG.N) . Investors will also be watching earnings from streaming giant Netflix (NFLX.O) and electric car maker Tesla (TSLA.O).

Signs that U.S. corporate earnings are set to be higher than expected this year could strengthen the case for other market sectors, including banks, travel agencies or other companies that benefit from a slowing economy. growth, or high-growth and tech names that have mostly driven stocks higher. of the last decade.

Defensive actions have proven themselves in the past. DataTrek Research found that the healthcare, utilities, and commodities sectors have outperformed the S&P 500 by 15 to 20 percentage points during times of economic uncertainty over the past 20 years.

Lauren Goodwin, economist and portfolio strategist at New York Life Investments, said the firm’s multi-asset team had in recent weeks shifted its portfolios to basic, healthcare and utilities stocks and reduced exposure. financial and industrial.

Expectations of a more hawkish Fed have “raised the risk that this economic cycle will be shorter and hastened our shift in allocation to these defensive equity sectors,” Goodwin said.

The Fed – which raised rates by 25 basis points last month – has signaled that it is ready to resort to larger rate hikes and quickly unwind its nearly $9 trillion balance sheet to drive down inflation. Investors were also troubled by geopolitical uncertainty stemming from the war in Ukraine, which pushed up commodity prices and helped boost inflation.

With prices soaring, defensive stocks can also be “inflationary hedges to some degree,” said Mona Mahajan, senior investment strategist at Edward Jones.

“When you think about where there’s a little more pricing power, consumers will have to buy their basics, their health care, probably pay their utility bills, regardless of price increases,” he said. Mahajan.

Not all investors are pessimistic about the economic outlook, and many believe momentum could quickly shift to other segments of the market if it appears the economy will remain strong.

Art Hogan, chief market strategist at National Securities, puts the risk of a recession at 35% this year, “but that’s not our base case.”

“As concerns about an impending recession fade, I think the sponsorship of defenders will subside with that,” Hogan said.

The surge in defensive stocks pushed up their valuations. The utilities sector is trading at 21.9 times earnings forecasts, its highest level on record and well above its five-year average price-to-earnings ratio of 18.3 times, according to Refinitiv Datastream. The commodities sector is trading at a premium of around 11% to its five-year average P/E, while healthcare is trading at a premium of 5%.

“It wouldn’t surprise me at all to see some mean reversion on this trade for a while,” Todd said. “But as long as these growth concerns persist, you could continue to see these areas outperform relatively.”

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Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili, David Gregorio and Lincoln Feast.

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