Morgan Stanley studied decades of stock market history and nailed down the best areas that protect against huge portfolio losses
- Morgan Stanley analysts recently published a “defensive scorecard,” highlighting the sectors that best withstood downturns over the past 25 years.
- “We think a rotation to more defensive market leadership is coming later this year and into 2019,” they said.
- They included top stock picks in the six top sectors.
Not all defensive sectors are created equal. And when the next major stock market downturn hits, Morgan Stanley wants its clients to be positioned in the best-possible way.
A team of nearly three dozen analysts recently compiled a scorecard of the best defensive sectors, based on their study of nearly 25 years of market data. They acknowledged it’s a limited timeframe that spans three cycles at most and is skewed by the tech bubble and credit crisis. Still, they considered the study a good starting point for thinking about the next downturn.
Michael Wilson, the chief US equity strategist, warned that higher interest rates and less synchronous economic growth would lead to more volatile markets. He now reckons that an extended bear market may already be underway, but will lack the big 20%-40% pullbacks that characterized the last three bear periods dating back to 1987.
“We think a rotation to more defensive market leadership is coming later this year and into 2019 as the market begins to contemplate slowing growth and an aging cycle,” the analysts wrote in a note on Thursday. “Before that rotation begins in earnest, we test traditional notions of defensiveness and assess if what was defensive in the past will continue to be so in the future.”
Starting with what doesn’t work well during downturns, they found that financials saw the largest decline in both returns and risk.
And in assessing what works defensively, they looked into which sectors tend to outperform the market during its sharpest downturns, defined as the bottom quintile of weekly returns. They also examined relative performance during monthly market downturns, performance at times when volatility spikes as prices are falling, and the volatility of weekly returns.
Here are the sectors they identified as “defensive classics” because their current fundamentals do not suggest they’ll be any less protective in the future:
Aerospace & Defense
Aerospace on its own is cyclical because it relies on the airline industry, which tends to sway with the economy.
However, defense stands out as one that generates revenue from the government even when the rest of the market is faltering, the analysts said. The Trump administration requested $716 billion in 2019 defense spending from Congress, a 13% increase over 2017, and this escalation is bullish for companies that supply the government, according to Morgan Stanley.
“In addition, while relations with North Korea could potentially improve, developments in the Middle East maintain the elevated threat environment as do uncertain China / Russia relations,” they said. “Net-net, we forecast a 10-15% total return annually for Defense Primes, consisting of 10%+ annual growth and a 1-2% dividend yield through decade-end.”
Their top pick for this sector is Lockheed Martin.
The higher pricing power of the companies and higher growth outlook are among the reasons why this is one of the best defensive sectors, the analysts said.
One concern they have for household products in general is that competition from Amazon and discount retailers could keep prices in check. While that’s good for consumers’ pockets, it could mean less revenues for companies.
Beverages, however, don’t face this headwind as much because of the diverse locations at which they’re sold, fewer private-label offerings versus household and personal care products, and immediate consumption.
Morgan Stanley’s top pick in this sector is PepsiCo.
Healthcare Equipment & Supplies
This is a sector that’s relatively guarded from healthcare-specific risks such as the pressure to lower drug prices, Morgan Stanley said.
Also, greater innovation in the space as well as growth in emerging markets should support the sector.
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