Defensive, energy, dividend plays gain favor as market pulls back

By Lewis Krauskopf

NEW YORK (Reuters) – Fresh volatility in U.S. stocks is prompting some investors to dive into sectors of the market that have been relatively strong during a brutal year for stocks, including energy stocks, defensive names and dividends.

The S&P 500 is down 9% since mid-August, partially reversing a summer rally after Federal Reserve Chairman Jerome Powell warned that the central bank’s unilateral fight against inflation could lead to financial pain.

While few sectors of the market have been spared during the index’s selloff of nearly 18% this year, some have fared comparatively better, with bullish investors hoping to cushion further losses in their portfolios if asset prices remain volatile.

Sectors such as consumer staples, health care and utilities have fallen less sharply than the broader S&P 500 throughout the year. Investors tend to gravitate to companies in these regions during uncertain times, expecting consumers to continue spending on medicine, food and other necessities despite economic turmoil.

The energy sector remains one of 2022’s biggest winners with gains of 44% year-to-date despite the recent pullback.

At the same time, the prestigious S&P 500 dividend index, which tracks companies that have raised dividends annually over the past 25 years, is down about 10% this year, a less severe decline than the overall market decline.

“These ‘steady Eddie’ types of names could tread water in a down-sloping market,” said Chad Morganlander, a portfolio manager at Washington Crossing Advisors, who manages a strategy that includes companies he expects to increase dividends in the coming months, including Johnson. & Johnson and Clorox Co.

The S&P 500 ended the week down 3.3%. The index fell 1.1 percent on Friday after early gains from a U.S. jobs report that showed a labor market that may be starting to ease gave way to worries about the European gas crisis.

The rally that fueled stocks for most of the summer took a big hit, with the S&P 500 now up about 7% from mid-June. Should the index hit new lows again this year, it would be the fourth time stocks have gained at least 6% before retreating to a new 2022 low.

The rapid recovery in bond yields has further complicated the outlook for stocks, putting tech and other growth stocks that are more sensitive to rising yields under particular pressure.

“The pullback in stocks … and the rise in yields are consistent with our view that investors had underestimated the willingness of central banks to tighten policy at current rates of inflation,” UBS Global Wealth Management wrote this week.

The firm recommends tilting portfolios toward defensives, including pharmaceutical stocks, and so-called quality companies whose characteristics include higher-than-average dividend yields and low debt-to-equity.

Concerns that the Fed will struggle to reduce inflation – which rose at its highest rate in more than four decades this year – were another catalyst for investor diversification. A roughly 20% rise in Brent crude oil has helped make energy stocks a favorite this year, while putting upward pressure on consumer prices.

“I’m not convinced that equity investors have a full appreciation of the impact of inflation on their portfolios,” said John Lynch, chief investment officer at Comerica Wealth Management, citing the impact on the economy from higher interest rates and eroding profit margins. from the highest. Court fees.

In recent weeks he has bought more shares of energy companies, betting that supply constraints will continue to push oil prices higher. Lynch has also acquired stocks in the health care sector, which he believes are more reasonably priced than other defensive sectors of the market.

Of course, sectors that have outperformed this year come with their own risks. Energy prices have been volatile and could fall if a recession curbs global demand, squeezing energy stocks.

Some defensive areas, particularly the utilities and commodities sectors, are trading at significantly higher price-to-earnings valuations than their historical averages. Investors could also abandon defensive plays if the economy avoids recession.

Horizon Investment Services owns shares of utilities, but “we’re not all just defensive,” said Chuck Carlson, the firm’s chief executive.

“Some of these areas are quite expensive,” Carlson said. “You pay for this defense.”

(Reporting by Lewis Krauskopf in New York; Editing by Ira Iosebashvili and Matthew Lewis)

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