Defensive stocks aren’t just for bear markets.
That’s the reminder Morningstar gives investors in a recent market analysis. “After providing a cushion to investor portfolios during the bear market of 2022,” Morningstar’s Jülide Sengil writes, “defensive stocks have lagged the broader market as stocks rebounded this year. The good news for long-term investors looking for opportunities here is that many names are trading in undervalued territory.”
It’s a two-pronged note. First, the team at Morningstar flags five specific companies they view as being good buys. That’s helpful, to be sure, but perhaps even more important is their broader message: Don’t neglect defensive stocks, even as the S&P 500 has surged nearly 20% this year. Don’t wait for a bear market to invest, because the whole point of these assets is that you already own them when those rainy days inevitably come.
A financial advisor can help you diversify your portfolio and respond to both bear and bull markets, alike. Find a fiduciary financial advisor today.
What Are Defensive Stocks?
Defensive stocks are a risk mitigation asset. They are equity shares in companies that tend to perform well regardless of economic conditions. As SmartAsset writes in its guide on defensive stocks:
“While [defensive stocks] may lag the overall market during growth periods, they provide a steady return when the economy stalls or dips into recession.”
For example, health care and utilities are classic defensive stocks. People need their prescriptions, lights and drinking water regardless of economic conditions. So demand for these services tends to be less volatile than many other products and services.
This gives defensive stocks their risk-mitigation footprint. With a relatively stable business cycle, these stocks generally hold their value well during bear markets and recessions. But lower volatility also tends to mean lower growth. While these companies generally don’t lose significant demand during a bear market, they also don’t see outsized gains during bull markets. In the same way that patients don’t need less medicine in a recession, they don’t suddenly need more in times of growth. All in all, these are the steady, stable performers in your portfolio.
Why Hold Defensive Stocks?
If defensive stocks are for market downturns, why do some advisors recommend that you keep a basket of them at all times? Morningstar’s recent analysis echoes the consensus on this issue: these are good stocks to own for multiple reasons.
First, no one can truly predict when a recession or bear market will come. As the old saying goes, economists have predicted nine out of the last five recessions. That’s certainly true in the current market, where analysts, like at the NY Times, have predicted a next-quarter recession for the last five quarters.
If you already own defensive when a bear market hits they presumably won’t lose value along with the rest of your portfolio. If you’re scrambling to buy them during a downturn, it defeats much of their purpose.
Second, defensive stocks are often a more expensive investment in a downturn. During a bear market, defensive stocks typically take on a price premium. People will pay more for stable assets, so they’ll be more expensive relative to other investments. At the same time, if you have liquidity to invest during a downturn you often want to put it in undervalued assets poised for future growth, which may not be defensive stocks.
By waiting until a bear market hits to buy defensive stocks, you can overpay for these assets and lose the opportunity to buy underpriced investments. The real value of defensive stocks is already owning them when the market goes south, and that means keeping them on hand and ready.
What Makes for Good Defensive Stocks?
As Morningstar notes, there are two good things to look for in a defensive stock: durable industries and economic moats.
As we mentioned above, a durable industry refers to one less exposed to economic cycles. These are products and services that people need regardless of prevailing conditions. Standard defensive industries include:
- Consumer retail, such as grocers and drugstores
- Military defense
- Health care
- Food manufacturing
- Utilities
This isn’t to say these sectors are entirely immune to downturns. In a recession, people do economize on their grocery runs and put off optional doctor’s appointments. But there are support and resistance bands. People still need some food and medicine. They can’t cut those out the way that they can simply stop buying video games or forgoing a vacation.
Morningstar also recommends looking for companies with economic moats. This refers to when a business has a significant competitive advantage that will be expensive, time-consuming or otherwise difficult for competitors to overcome. For example, a retailer with a large network of existing stores might have a wide moat, because someone would need to duplicate that physical infrastructure before they can threaten that retailer’s business.
Like a durable industry, economic moats tend to make for better defensive stocks. The moat gives this company a more stable place in the market, which makes it less volatile during downturns.
Morningstar has flagged five companies for summer 2023 that it particularly likes as undervalued defensive stocks. They are:
- CRISPR Therapeutics
- CVS Health
- Moderna
- Tyson Foods
- The Kraft Heinz Co.
Each of these companies are from traditional defensive industries, either food or health care. And, as of the time of writing, all have relatively low P/E ratings, making them potentially better buys overall.
Bottom Line
In a recent market analysis, Morningstar reminds investors not to neglect the defensive stocks in their portfolio. Defensive assets refer to companies and entire industries that perform well in variety of economic cycles. While the market turmoil of 2022 has passed and the stock market is surging, investors may now want to consider adding defensive stocks to their portfolios at a discount for future downturns.
Risk Management Tips
- A financial advisor can help you minimize risk in your portfolio and prepare for future uncertainty. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- For a more in-depth look at risk management, be sure to read our comprehensive guide on measuring and managing market risks, including interest rate risks and equity risks.
Photo credit: ©iStock.com/ridvan_celik, ©iStock.com/MortenElm