Everyone is expecting a recession, but playing defense, at least in the traditional way, has been a very bad idea in 2023.
The usual hiding spots—consumer staples, utilities, and healthcare—failed to offer protection, if protection was even needed. While the S&P 500 gained 8.9% during the first five months of the year, consumer staples slid 2.8%, utilities slumped 6.3%, and healthcare dropped 8.5%. Meanwhile, information technology and communication services, pockets of the market investors would typically shy away from in...
Consumer stocks like Colgate-Palmolive aren’t working as defensive plays this year.
Daniel Acker/Bloomberg
Everyone is expecting a recession, but playing defense, at least in the traditional way, has been a very bad idea in 2023.
The usual hiding spots—consumer staples, utilities, and healthcare—failed to offer protection, if protection was even needed. While the S&P 500 gained 8.9% during the first five months of the year, consumer staples slid 2.8%, utilities slumped 6.3%, and healthcare dropped 8.5%. Meanwhile, information technology and communication services, pockets of the market investors would typically shy away from in a downturn, both gained more than 30% over the same period.
Don’t expect traditional defensives to get their mojo back anytime soon—even if the economy does indeed contract. “Traditional defensives aren’t quite attractive,” says Sameer Samana, senior global market strategist at Wells Fargo Investment Institute. “They were a very crowded trade and were priced for perfection.”
Part of the problem is that too many people were expecting a recession. Consumer staples were particularly crowded, with names such as PepsiCo (PEP), Coca-Cola (KO), and Colgate-Palmolive (CL) being among some of the most held stocks by institutional funds, according to UBS Securities.
And for a sector known for its dividends, the yields aren’t particularly attractive. Investors are now getting roughly 2% to 3%, perfectly fine in a normal economy, but when savings accounts and money-market funds pay more than 4% in interest, investors are better off in cash. It’s a similar story with utilities and real estate: Both are traditional dividend plays in trying times, but with yields of 3% and 3.6%, respectively, they don’t provide a compelling opportunity in this environment.
Still, with the prospect of a recession looming large in the back half of the year, investors can be forgiven for looking to hide out in defensive sectors. They just may need to change their definition of defensive.
Outside of cash, Wells Fargo’s Samana favors energy and technology—albeit selectively. Energy companies have gotten religion on their spending since the last decade, when many overleveraged companies went bankrupt. They now operate lean—as though a recession is right around the corner. True, energy stocks have fallen 12.9% this year, but they are attractively priced, with the Energy Select Sector SPDR exchange-traded fund (XLE) trading at 6.5 times forward earnings, with yields nearing 4%.
Meanwhile, tech has become “quasi-defensive,” Samana says, as companies have no choice but to continue spending on software, cybersecurity, and communication services. Tech names with more of a consumer-discretionary bent may see weakness, but more enterprise-focused names should do well.
Maybe more than semi-defensive. The key to playing defense in this or any economic cycle isn’t just about picking sectors but favoring stocks that have strong free cash flow, resilient balance sheets, “wide moats” to protect against other competitors, and products people will buy no matter the price, Nicholas Colas, co-founder of DataTrek Research, told Barron’s. Tech companies fit the bill. They were also oversold heading into 2023, have been cutting costs, and are benefiting from a boom in artificial intelligence.
“Defense is what works when nothing else does,” Colas says. “It is very hard to argue against tech.”
You won’t get any arguments from us.
Write to Carleton English at carleton.english@dowjones.com