Friday, February 3, 2023
HomeMarketStocks' Rally Looks Shaky. How to Play Defense for 2023.

Stocks’ Rally Looks Shaky. How to Play Defense for 2023.

Defensive end Payton Turner of the New Orleans Saints blocks a field-goal attempt by the Atlanta Falcons on Sept. 11, in Atlanta.

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Talk of a 2023 recession is everywhere. Wall Street strategists and fund managers are getting ready.

Inflation remains a problem, and a shakier growth backdrop in the U.S. and abroad could drag down earnings, so strategies to play defense are in vogue. The trick is to find investments that aren’t overrun by other people seeking shelter.

The traditional defensive companies in the market are those whose day-to-day businesses aren’t affected by changes in gross domestic product, interest rates, or market fluctuations. Think of sectors like consumer staples, healthcare, and utilities. People still need to buy toothpaste, visit the doctor, and light their homes when the economy tanks, so earnings and sales from companies in those areas tend to hold up best.

A 13% surge in the S&P 500 in just six weeks raises the bar for investors, making additional short-term gains less likely. That October and November rally has been led by cyclically oriented stocks and sectors, including materials and industrials. A tough third-quarter earnings season for Big Tech firms has held back technology and many growth stocks, despite a decline in bond yields. Defensive groups have held their ground, having rallied earlier in 2022.

The recent rally has been underpinned by hopes that the Federal Reserve will pause in its interest-rate hiking campaign, spurred by encouraging inflation and jobs data. But inflation remains far above the Fed’s 2% target, and the path back down isn’t guaranteed to be smooth.

Rates will continue to rise, and the cost of getting inflation under control may be significantly slower, or negative, economic growth. That will be reflected in lower earnings for companies whose businesses are sensitive to changes in consumer or business spending, commodity prices, or trade with other economies. Continued volatility in asset markets will make the steadiest firms more attractive.

That 2023 might bring a growth slowdown or recession isn’t a surprise, however. Many defensively oriented stocks are trading at hefty premiums to the market. Consumer staples stocks in the S&P 500 trade an average of 21 times the consensus call for 2023 earnings per share, versus 17 times for the overall S&P 500. Utilities stocks go for 19 times and healthcare stocks go for 18 times. (The cheapest S&P 500 sector is energy, at less than 10 times next year’s consensus earnings, while financials are at about 12 times.)

“Stretched valuations are not unusual through equity bear markets and not a roadblock for staples, telcos and utilities to outperform the [S&P 500,]” wrote Martin Roberge, portfolio strategist and quantitative analyst at Canaccord Genuity. “In all, it looks too early to reduce exposure to defensive stocks.”

Credit Suisse
‘s chief U.S. equity strategist Jonathan Golub screened for S&P 500 companies that have exhibited below-average exposure to broader economic conditions, looking at how businesses have reacted to changes in various proxies for the strength of the economy. On the list are commodity prices, the cost for companies to borrow relative to yields on government debt, and other factors.

Pharmaceuticals companies
Johnson & Johnson
(ticker: JNJ),
Pfizer
(PFE), Merck (MRK), and
Amgen
(AMGN) all made the cut. Among consumer staples,
Kroger
(KR),
J.M. Smucker
(
SJM
),
Kraft Heinz
(KHC), and
Altria Group
(MO) could be opportunities, he found.

Utility stocks passing Golub’s screen include Dominion Energy (D),
FirstEnergy
(FE),
Entergy
(ETR), and
Public Service Enterprise
(PEG). Telecommunications firms
Verizon Communications
(VZ),
Comcast
(CMCSA), and
Charter Communications
(CHTR), plus the real estate investment trusts
Realty Income
(O),
AvalonBay Communities
(AVB), and
UDR
(UDR), round out the list.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

Credit: marketwatch.com

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