Three Defensive Sectors for a Volatile 2019 March 8, 2019

2018 was the worst performing year for the stock market in a decade since the Global Financial Crisis in 2008. The Dow Jones Industrial Average, S&P 500 and NASDAQ were down 5.6%, 6.2% and 4% respectively.¹ After the volatile end to 2018, investors are bracing themselves for an unpredictable new year, with the US-China trade war and the uncertainty of Brexit weighing heavily on their minds.

During uncertain times like these, investors may try to adopt a defensive investment strategy aimed at minimising the risk of losing their investment principal. Besides allocating a greater proportion of the portfolio into conservative asset classes like bonds and cash equivalents, investors may also consider investing in defensive sectors.

Cyclical Sectors vs Defensive Sectors

Before we introduce you to the defensive sectors, let us discuss the differences between cyclical sectors and defensive sectors. In financial terms, a sector refers to an area of an economy in which the businesses share the same operating characteristics, related products or services.

Cyclical sectors are highly responsive to the economic cycle. These sectors usually have high earnings volatility and operating leverage. Their products and services are generally expensive non-necessities. The purchase of these products and services can be delayed until the economy improves. One good example is the automobile sector. Many consumers will be unwilling to buy a new car when the economy is spiralling downhill, and this in turn affects car manufacturers’ revenues.

In contrast, defensive sectors produce goods and services for which demand is relatively stable. Food producers and basic services, such as supermarkets or drug stores, are examples of defensive industries in which revenues are less dependent on the economic cycle. An individual may have decreasing income but he/she is unlikely to reduce his/her food or medical spending significantly.

Examples of Cyclical Sectors and Defensive Sectors

You may find more details regarding the classification of the different sectors by reading MSCI’s Report.

Exchange-Traded Funds

Even though it might seem easy to rotate between sectors based on the economic cycle, identifying individual stocks within the respective sectors is a more complex activity. Exchange-Traded Funds (ETFs) provide a convenient vehicle for investors to gain access to specific sectors for their investment strategies, without the need for stock selection.

In addition, the exposure to a basket of underlying stocks in an ETF reduces the concentration risk and volatility of the investment portfolio.

You may explore different ETFs with different sector exposure using our ETF Screener.

So what are the defensive sectors that investors may consider in a volatile market for 2019?

Healthcare

The healthcare sector did not just survive a volatile 2018. It thrived. Healthcare was the top performing S&P 500 sector last year, with a respectable gain of 6.5%.² It is projected that global healthcare spending will reach US$10.059 trillion by 2022. Driven by a global ageing population and clinical technological advancement, the healthcare industry is estimated to have an annual growth rate of 5.4% from 2018 to 2020.³

Utilities

Amidst some chaos seen by markets last year, the utilities sector has been slowly creeping back into the spotlight. The sector fell out of favour from 2016, broadly underperforming compared to other sectors within the S&P 500. However, the utilities sector has historically outperformed the broader market index in a down market. To illustrate, the utilities sector had an average yield of 4% on 31 October 2018, outperforming all the other S&P 500 sectors. It managed to record a positive gain after the stock market lost nearly US$2 trillion in the month of October.⁵

With the utilities industries leveraging new technologies to serve increasingly sophisticated customers and to improve operational efficiencies, we can expect utility capital expenditure in 2019 and 2020 to continue to stream in.⁶

Besides, utilities like water, gas and electricity are necessities during all phases of the economic cycle and consumers are unlikely to cut out these products and services from their daily lives.

Consumer Staples

Consumer Staples refer to essential products such as food, beverages, tobacco and household items. They are goods and services that people are unable or unwilling to cut out of their budgets, regardless of their financial situation. The consumer staples sector is typically viewed as a safe haven during periods of market volatility and economic downturn.

Increased geopolitical tensions and political anxiety arising from the US-China trade war may drive nervous investors to seek short-term shelter in the consumer staples sector and then rotate out of this sector once the global economic situation improves.

All ETF Information is accurate as of 20 February 2019

Conclusion

2018 has been a roller coaster ride for investors, with steep drops on one day followed by sharp rebounds on the next. The market volatility is unnerving for investors but that does not mean that one should bypass the equity market in 2019 entirely.

Defensive sectors offer investors an interesting option to stay in the market and participate in any potential upside gain while providing some buffer against a downturn in market performance.

Past performance is not a guarantee of future results, but defensive sectors have often outperformed their cyclical counterparts during an economic downturn. It is also important to note that defensive sectors may not necessarily grow during down markets but they tend to “lose” less as compared to cyclical sectors that are more sensitive to the economic cycle.

ETFs with exposure to defensive sectors can be an important stabiliser to an investor’s portfolio during periods of market volatility or economic downturn. Alternatively, investors may utilise them as an investment tool for their sector rotation strategy and swap to cyclical sectors once market conditions improve.

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