Are Defensive Stocks Defensive?

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Do defensive stocks protect your portfolio during a fall?

Unseen international frictions on both a political and economic sphere often make tensions arise, which causes promising numbers to be corrected downward. China published rather bad industrial export numbers, and fund managers report a strong flight, from stocks and bonds.

In the graph above, on the left side you can see the phenomenon of an inverted interest curve, where the short-term interest almost results in a higher yield than the long-term interest. This curve and the signals for a nearing recession (see the right side with predicting ECRI-index) remind investors of the famous market fall of 2008.

Yet, this trend turn commenced a few months ago, which made loved shares fall through their upward price trend one by one. As I described earlier, “In order to halt this spiral, investors are in dire need of good news. America holds the power here…!”

More defensive stocks are currently protected from these new economic price developments. For these types of stocks, investors will receive a higher risk premium thanks to the higher dividend yield, the higher book value against market value and the lower price/profits proportion. 

Defensive stocks are part of defensive sectors. The main ones are: 
Pharmacy (+1,7%), Utilities (+0,3%) and Nutrition (-3,3%). So, they are companies that offer resistance the longest due to “the necessity for food, medicine and energy”. 

Growth stocks, on the other hand, are those with high growth potential and very good forecasts. Due to the changes in conjuncture, the chance that those expectations can no longer be met increases.

Are defensive stocks a safe haven during a steep market fall?

In order to examine this, let’s have a look at the three biggest falls over the past 20 years. In the table below, see the results of 5 market indexes and 10 defensive stocks.

Market indexes:

  • Bel20, Cac40, Dax30, AEX, Swiss

Stocks:

  • Nutrition: Danone, Nestlé, Unilever
  • Untilities: E.on, Engie, RWE, Veolia Env
  • Pharmacy: Merck, Novartis, Ucb

I’ll take two periods:

  • Three months after the top of the market
  • From the top to the bottom of the market

Why do I pick two periods for my analysis?

Defensive stocks hold up well at the start of a price fall. The high payout and low price/profits proportion justifies this price drop. At the same time, the first stage will cause a flee to “safe-haven stocks”, and the buyers/sellers will temporarily keep the price balanced. 

What does this table show you?

The losses for defensive stocks are clearly better in the first stage, but if the fall persists defensive stocks take hits as well. Yet, the results remain better than the market average. If, however, we take into account the fact that investors generally have a non-defensive portfolio next to their defensive stocks, the difference is small.  

The table also tells us that diversification is important.
For one market fall, a certain sector or country outperforms a different sector or country. For the current correction, notice two important elements which help you improve the returns on your portfolio: 

  • the strenth of the Pharma sector;
  • the strength of the Swiss market.
    While most markets will create a new bottom and quote at the lowest price in two years once again, the Swiss SMI index doesn’t even create a lower bottom in one year!

By comparing the strength of market indexes and sectors on a regular basis, you will find the differences quickly and can act accordingly.

Conclusion

Investors in stocks find the most benefits in cash when a trend turns.  In this contribution, I regularly emphasize the important to build cash whenever the market sentiment goes red.
In this way, you will possess the means when the trend recovers at the same time.

Of course I am aware that a correction that lasts very short will lead market indexes to perform better because of your cash. On the other hand, nobody can predict the duration, and the trend will be negative as long as there are no new tops and higher bottoms.

The dilemma to get in early is only available for fund managers who have to measure against benchmarks.

As a long-term enjoying, private investor, you luckily have the possibility to sit by the sidelines and wait until the storm passes… 


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Paul Gins
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The trend is your friend

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