Defensive stocks become hideout for investors in a rocky market

Shares of utility, consumer-staples and healthcare companies have weathered the storm better than most of the market this year. Consolidated Edison Inc., Campbell Soup Co. and Merck & Co. Inc. are among the standouts, each rallying double-digit percentage points in 2022.

These sectors are often thought of as defensive areas of the market, which means their earnings are somewhat shielded from a slowing economy. The idea is that consumers still pay electricity bills, buy groceries and pick up prescriptions even when times get tough.

To be sure, those sectors haven’t posted huge share-price returns. But their modest losses compare with year-to-date downturns of 42% and 39% in the communication-services and consumer-discretionary sectors, respectively. The only sector to beat defensive stocks in 2022—energy—has rallied because geopolitical strife sent oil prices surging at points this year.

The S&P 500 utility stocks as of Wednesday are down 1.2% for the year, consumer staples are down 3.1% and healthcare stocks are down 4.2%. The S&P 500, meanwhile, is off by nearly 21%.

The S&P 500 utilities and healthcare sectors are both beating the broad index in 2022 by the widest annual margin since 2000. The consumer-staples sector’s lead over the S&P 500 is on pace to be the biggest since 2008.

“There’s nothing necessarily fundamentally exciting going on in the defensive areas. They’re just a good place to hide,” said Thomas Martin, senior portfolio manager at Globalt Investments.

The relative strength of defensive stocks underscores how this year’s bruising financial conditions have shaken up just about every corner of the market. The Federal Reserve’s bid to calm persistent inflation through aggressive interest-rate increases has changed investors’ risk calculus to favor stocks that reward shareholders now, rather than down line.

Investors also have sought out defensive stocks for the steady cash they are known to offer. Many companies in defensive sectors pay hefty dividends, giving investors a regular stream of income even when share prices are struggling. Companies in the S&P 500 utility and consumer-staples sectors offer a dividend yield of roughly 3% and 2.6%, respectively, among the highest payout percentages in the index, according to FactSet.

Lisa Erickson, head of the public markets group at U.S. Bank Wealth Management, said her firm advised clients this year to favor dividend-oriented stocks, given the rocky market conditions. She believes the first half of 2023 could continue to pose challenges for investors, and she is continuing to recommend dividend-paying shares going into the new year.

“We’ve had a perfect setup for defensive companies,” she said. “With that type of volatility expected again, companies that can provide more of a cash-flow buffer in their returns look attractive.”

Some investors say defensive stocks now seem a bit pricey compared with other parts of the markets. Wall Street often uses the ratio of a company’s share price to its earnings as a gauge for whether a stock appears cheap or overpriced.

The S&P 500 consumer-staples sector is trading at roughly 21 times projected earnings over the next 12 months, according to FactSet, as of Tuesday’s close. The index’s utility and healthcare stocks’ multiples are around 19 and 18, respectively. That means defensive stocks could be considered a bit more overvalued than the S&P 500, which has a price-to-future-earnings ratio of about 17.

Chris O’Keefe, lead portfolio manager for Logan Capital Management’s dividend-growth strategy, said the firm has been trimming some of its holdings in healthcare and consumer-staples stocks as those segments have gotten relatively more expensive, while adding to some consumer-discretionary names like Nike Inc. and Starbucks Corp.

Still, Mr. O’Keefe said his portfolio remains overweight in healthcare and consumer-staples stocks, as those companies should continue to perform well in the coming year as the Fed keeps raising rates.

“We still believe that companies that have more predictable earnings are going to continue to do better here,” he said. “You always know those companies are going to do well when the punchbowl is taken away.”