Why Defensive Stocks Lead Market As Investors Recall 2008 Meltdown

Despite the market’s rally to new highs in 2019, three out of the four top performing sectors that have led the S&P 500 in the past twelve months are defensive plays. The outperformance of the real estate, utilities and consumer staples sectors, known to be safer corners of the market, is driven in part by investors' desire to prepare for the kind of massive market pullbacks seen last year and even in 2008, according to a story in the Financial Times as outlined below. The financial crisis pushed the stock market down by more than 50%.

What It Means For Investors

“In 2008, the market was caught completely off guard,” said Rob Almeida, a global investment strategist with Boston-based MFS Investment Management, which manages $489 billion in assets. “Equity investors are thinking, ‘I won’t let that happen to me this time.'” 

Investor caution is striking at a time when soaring stocks, otherwise, might indicate excessive optimism. That's shown by the American Association of Individual Investors’ latest survey, in which the percentage of people who say they expect U.S. stocks to decline or remain flat over the next six months is now higher than those who are more bullish on equities.

While the S&P 500 has returned around 20% this year, these three sectors have outperformed over the 12-month period, when the S&P 500 has risen just 7%. Investors also are concerned about a re-escalation of trade tensions with China, forecasts of a sharp slowdown in corporate profits and the risk of an economic recession. “Investors are getting more cautious,” says Almeida. They are “repositioning away from companies that are not sustainable earnings compounders, and into companies that are more consistent,” he adds.

Defensive Risks

If the Fed cuts rates as expected, analysts at Goldman Sachs say the defensive sectors are likely to “repeat the historical pattern and outperform if economic data remain weak enough to motivate an extended Fed easing cycle.” 

Bond proxies such as real estate and utilities have done especially well in anticipation of Fed easing, per Bloomberg. This has led the valuations of U.S. defensive stocks to their highest in six years, while high-quality equities in Europe reach new records. 

But even defensive stocks may be getting risky. Increasingly inflated valuations for defensive stocks prompted Columbia Threadneedle to sell some of its rate-sensitive defensive names and buy cyclical stocks earlier this summer, according to Bloomberg in a story in late June. “Valuations are pretty stretched,” said portfolio manager Frederic Jeanmaire.

Looking Ahead

Whether or not investors continue to favor defensive stocks may depend heavily on how deeply the Fed cuts rates this week and if the U.S.-China talks lead to a new trade agreement. If both lead to positive outcomes, many investors may jump again into riskier stocks and leave their defensive plays behind to ride the next leg of the bull market.