At a time of ongoing economic uncertainty, investors seek investments that can provide additional downside protection.
Within equity markets, it is traditionally those sectors that are less sensitive to volatility which have acted ‘defensively’, this includes Consumer Staples, Health Care, Utilities and Telcos. However, as bond yields have taken another leg higher over the past 6 months, higher growth sectors such as Tech and Consumer Discretionary have relatively held up much better.
On valuation grounds, this doesn’t make any sense given that longer-dated cash flows carry greater duration sensitivity, but perhaps the outperformance is explainable from their move ahead of the pack to rapidly reduce costs and a consumer that has proven to be more resilient than expected.
The chart below shows the significant outperformance of ASX 200 Tech (green line) and Consumer Discretionary (blue line) sectors versus ‘defensive’ sectors, Consumer Staples (purple line) and Health Care (yellow line) over the past 12 months.
Source: FactSet, Clime Investment Management
What makes a stock defensive when inflation is high? There will come a time when the rise in bond yields will slow and a mean reversion should occur in those sectors that have been hit, especially in those ‘defensives’ that are typically less sensitive to bond yields but have still been sold off.
However, it may turn out that a better place to hide is in those sectors offering higher amounts of growth, outstripping inflation, in addition to benefitting from structural tailwinds and the eventual flatlining or decline in long duration bond yields.
As Mark Twain once famously said, “History never repeats itself, but it does often rhyme”, however, perhaps this time it is different.
Time will tell.
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