If you drove a new car off of a car lot recently, you are likely one of the few driving around your neighbourhood with the latest model. When the markets are down, big ticket items like car sales are one of the first sectors to see sales slowdown.
SUV sales, on the other hand, are booming. A good defensive strategy would have been to invest in BMW, Lexus, or another car maker with strong SUV sales. When economic times are tough, invest in products that people will buy. Market corrections are a time for frugalness. The SUV not only accommodates the whole family but is perfect for carpooling to work or sporting events.
Generally, though, you want to eschew cyclical industries such as the automotive sector that is sensitive to up and down cycles in the economy. These so-called cyclical industries do badly in a slow economy.
Defensive stocks do well in good times and bad and should be part of every portfolio. During a bear market or recession, defensive industries do better than other industries. When central banks lower interest rates to encourage spending, defensive stocks continue to pay high dividends.
Invest in these top defensive sectors and insulate your portfolio against a downturn.
Consumer staples are non-cyclical stocks that will continue to do well when cyclical sectors such as manufacturing are down. Food, healthcare and drug company sales remain stable no matter what the broader economy does. Pharmaceutical and biotechnology stocks did well in 2015, despite several market corrections. Consumer staples also include the sin stocks. People still smoke and drink, and possibly even more, during a bear market.
Food and Beverages
Food and beverages are basic needs. You may cut down on discretionary items such as yoga lessons and entertainment, but your food budget is less likely to change. Some food brands seem to be internally popular, from generation to generation. When changes in the food industry do happen, the change is quick.
Companies such as Coca-Cola are quickly diversifying into healthy drinks and away from sugared water. Healthy eating is the growth trend. For decades, neighbourhoods hosted one natural food store. Today, health food stores are popping up on every corner.
Pharmaceuticals and Biotechnology
In the maturing pharmaceutical sector, an attractive large-cap company has revenues from drug sales and some promising drugs coming down the pipeline. Ideally, promising drugs are at various stages of regulatory approval providing a mix of high growth new drug and maturing product revenues. Pharmaceutical ETFs shook off this year’s market routs and continued to deliver positive returns.
The healthcare sector has always been a reliable defensive industry. As we live longer, we are spending even more in the healthcare industry over our lifetime. Healthcare sector investing can range from long-term care homes to health insurance to hospitals. Each of these businesses has different business models and dynamics and require separate due diligence.
The lights will stay on, whether or not the economy tanks. It may be time to pile up on water, gas and electric utility industry stocks. Be careful, though. These businesses are no longer controlled by regulated monopolies. Competition is good and bad. Utilities still pay solid and steady dividends. Many utilities have also expanded into unregulated energy businesses. You can no longer assume you are investing in your grandfather’s local utility.
Read the annual report to understand the businesses your diversified utility is in, and compare the financial ratios to its peers. Competition has unleashed a flurry of competition in the energy markets. One attractive area is clean energy technology. A few clean technology ETFs ended 2015 in positive territory. The ISE Global Wind Energy Index Fund (ISE) was up over 11% on the year.
Defence & Aerospace
The defence industry has led many economies out of recession. Defence is also an industry that likes M&A activity. The mobilization of military production during World War II is credited with increasing the GDP of the allies and bringing women into the workforce to help meet demand. The iShares US Aerospace & Defense ETF has a 3-year return of 20.50%. This ETF is full of defence stalwarts, including Boeing, Lockheed Martin, and Raytheon.
Do Your Due Diligence
Consumer staples should still pass your investment screens. Check out the 3- or 5-year, and 12-month trailing earnings per share and return on capital (net operating profit after taxes divided by capital). The company’s profitability should not be rising and fall with economic cycles – the definition of a cyclical stock.
Put another way, the stock should have a beta in the 1 region or lower. The beta is a measure of the how the stock moves in relation to the market. Ensure the company has a solid dividend-paying history and dividend yields are above 2%.
Consumer staples funds provide a diversified mix of defensive consumer stocks. The Fidelity Select Consumer Staples Portfolio has a 10-year return of 10%.
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