It is a curious feature of the investment markets of the past decade that many typically defensive stocks performed well, even as economic growth was strong and investors sent markets to new highs.
The reason for these apparently contradictory scenarios is the policy of quantitative easing, which drives bond prices up and so increases the relative attractiveness of equities.
The equities that have most acutely benefitted from this trend for most of the past decade are the more defensive stocks.
This is because the defensive nature of those companies means they are viewed as similar to bonds, so if bond prices rise, then the price of a defensive equity can look relatively more attractive, even if the economy is growing.
So the circumstances would normally imply that defensive stocks should be out of favour.
This rotation by investors away from bonds and into safe haven equities, combined with allocating normally equities as a result of steady, if low, economic growth, powered record highs in many equity markets in recent years, while the bond buying programmes of central banks created a prolonged period of strong performance in fixed income markets.
Defensive stocks less secure
But the market trends of the past decade have started to unravel in recent months.
As central banks have cut interest rates and restarted quantitative easing, the market has responded by selling off defensive stocks, as part of a wider exit from equities.
Sunil Krishnan, head of multi asset funds at Aviva Investors said many of the defensive stocks look less secure now than has historically been the case because they have higher levels of debt than has typically been the case.
This makes them more vulnerable and less defensive, in the event of an economic downturn, as it will be more difficult to refinance that debt, in times of market turmoil.
This would lead to higher borrowing costs and so reduce the returns available to investors in those defensive companies even in times of market strife.
The most recent data from the Investment Association (IA) showed investors pulled £1.5bn from equities in September 2019, with outflows from every investment association sector bar emerging markets during the month.
Wayne Berry, investment manager at Brewin Dolphin, said the exodus from more defensive equities is the result simply of valuations becoming very high after a decade of strong performance, and that those stocks had become expensive relative to more economically sensitive companies, almost regardless of the wider economic outlook.
He said the shift in markets in recent months, has been driven by investors choosing to buy the cheaper stocks, based on their low price, instead of defensive shares, even if they are cautious on the equity market as a whole.
Debt levels and volatility
Andrew Cole, head of multi-asset investing in London for Pictet is also worried about the debt levels of the traditional defensive stocks, and this is one of the reasons why he isn’t allocating more capital to that part of the market despite the economic circumstances.