As market volatility returns, investors looking for a safe haven in the U.S. stock market are discovering that traditional defensive sectors may not be as secure as they once were. Sectors such as consumer staples, utilities, and healthcare, which held up well during last year’s sell-off, are showing signs of weakness this time around.
The benchmark S&P 500 has been fluctuating in recent weeks due to concerns that the Federal Reserve may raise interest rates higher than anticipated to combat inflation. This has caused sell-offs and prompted investors to seek refuge in so-called defensive names, which offer solid dividends and businesses that can withstand rocky times.
However, evidence that the U.S. economy remains strong and competition from short-term U.S. Treasuries and money markets that are offering their highest yields in years have weakened the argument for defensives in the initial weeks of 2023.
Furthermore, some defensive stocks are relatively expensive, which may deter investors even if the broader market sours. For instance, utilities, healthcare, and consumer staples held firm in last year’s punishing markets, but so far this year, they have been the three biggest decliners of the 11 S&P 500 sectors.
Valuations in some cases are also relatively expensive, with utilities trading at a nearly 20% premium to its historic average, while staples trade at a P/E of 20 times, about 11% above its historic average. Healthcare’s P/E ratio of 17 times is slightly below its historic average, but the sector’s financial prospects this year are relatively weak.
Investors remain divided on the prospects of defensives. Some believe that they could outperform again on a relative basis if concerns about recession spike, as they did last year. However, others argue that bonds are a better defensive position today than traditional defensive sectors.
High dividends helped defensive shares serve as a place to park money in turbulent times over the past decade, especially since safe assets yielded little. However, this dynamic changed last year as soaring inflation and the Fed’s rate hikes pushed up yields on cash and Treasuries.
In conclusion, investors searching for safety in the stock market may need to consider alternatives to traditional defensive sectors. While defensives can still be useful, they may not be the safe haven they once were. Investors should consider a balanced portfolio that includes a mix of stocks, bonds, and other assets to mitigate risk and maximize returns.