How One Subtle Change Could Make Market Storms Much Easier To Weather

How One Subtle Change Could Make Market Storms Much Easier To Weather
Milou Beunk

about 3 years ago3 mins

Mentioned in story

What’s going on here?

What with a vaccine-driven economic recovery, expectations of strong company earnings growth, and interest rates sat at ultra-low levels, stock markets are generally reckoned to be the most likely source of attractive investment returns in 2021. But with prices high, some think there could be a bumpy road ahead – boosting the case for ensuring your portfolio has a decent “defensive” element. And according to one major investor, you should also reconsider exactly what that involves.

What does this mean?

If you’re expecting stock markets to continue to climb to fresh record highs this year, you’re not alone: just about every major investment bank agrees. But consider the following: while the US S&P 500 index has delivered an average annual gain of 9% over the last four decades, the average intra-year drawdown each year was 14%.

S&P500 intra-year declines vs annual returns.
S&P500 intra-year declines vs annual returns. Source: JP Morgan Asset Management

Add in the S&P 500’s high price-earnings ratio – by one measure at its loftiest since 2001 – and it’s no surprise that the potential for market volatility is encouraging interest in defensive stocks. These companies are less sensitive to the economic environment, and therefore have more stable and predictable earnings. Up until last year, consumer staples and utilities – two sectors with just such defensive traits – had outperformed the foremost global stock index during every single one of the previous eight market declines of more than 10%.

MSCI World sector performance during downturns.
MSCI World sector performance during downturns. Source: Capital Group

But here’s the thing: it didn’t work in 2020. Utilities turned out to be one of the most volatile industries of all during the pandemic, and consumer staples stocks also saw wild price swings up and down.

S&P500 daily index moves S&P500 utilities index, March-June 2020.
S&P500 daily index moves S&P500 utilities index, March-June 2020. Source: Wall Street Journal

That’s why Capital Group – with $2 trillion of client assets, one of the world’s biggest investment managers – is proposing a new definition of “defensiveness”. Capital reckons companies exposed to new technology will benefit from strong growth regardless of how the economy is doing, while investing in firms with innovative business models that set them up for stable earnings offers another way to weather any upcoming storms in stock markets.

Why should I care?

If companies working with emerging tech are providing products and services with as-yet limited market penetration, they should have room to increase sales even if broader economic growth declines. Digital payments infrastructure, connected devices, and renewable energy are all areas of interest here.

Capital also highlights digital entertainment as a sector that’s increasingly essential for many people. Steady demand for online gaming, video streaming, and social networking may leave the likes of Activision Blizzard, Netflix, and Facebook looking pretty defensive bets.

New business models, meanwhile, can be found boosting resilience at companies in all sorts of sectors. Financial infrastructure firms like the London Stock Exchange are diversifying away from “cyclical” trading revenue and focusing more on selling recurring data subscriptions – an approach pioneered by software companies like Microsoft with their ongoing program access bundles.

Given their attractive characteristics, it’s unsurprising that many of these new “defensive” companies have seen their share prices rise recently. But Capital argues that paying a premium to buy these stocks isn’t such a big deal when you factor in their potential for strong earnings growth in the long run…

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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