Hold defensive assets in case of a correction

If a new trade deal is not agreed before the end of 2020, investors and markets will continue to worry about a harder form of Brexit until an agreement is reached.

Meanwhile, the UK continues to struggle with many of the secular trends evident in other developed economies, such as an ageing demographic, disappointing productivity and rising debt levels.

Defensive assets such as gold retain their attraction this year Tom Stevenson, Fidelity

Thus, during a weakening economy or periods of volatility investors will be hoping that by increasing their exposure to defensive stocks this will give their investments the right level of protection.

Defensive stocks

A defensive stock is a stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market. 

Within the equity part of the portfolio, water, gas, and electric utilities are an example of defensive stocks because people need them during all phases of the business cycle. 

Companies that produce or distribute consumer staples, which are goods people tend to buy out of necessity, regardless of economic conditions, are also generally thought to be defensive. 

Cash, gold, healthcare stocks and real estate investment trusts are also examples of defensive stocks.

Tom Stevenson, investment director for personal investing at Fidelity International says, owing to significant uncertainties in the year ahead both in the UK and beyond, this means demand for defensive assets is unlikely to disappear in 2020.

Mr Stevenson adds: “Defensive assets such as gold and, of course cash retain their attraction this year. Gold represents a good hedge against the possibility of rising inflation, which some believe could see a resurgence at some point. 

“It is important to hold some cash in reserve to take advantage of any market correction, which is significantly more likely at the end of a stellar year in the markets in 2019 than it was 12 months ago.

We cannot ignore the threat from higher inflation Kevin Boscher, Ravenscroft

“In an environment of persistently low interest rates, such as we are likely to see in 2020, the defensive attractions of high-yielding equities will remain compelling.

"Moreover, with the threat of widespread nationalisations off the table in the UK, traditionally defensive sectors like utilities are likely to bounce back.”

Nonetheless, the outlook for defensive assets will be challenging.

The returns on cash, gold, and defensive assets such as bond proxies are all under some pressure today with the move up in UK ten year gilt yields. 

Holding gold

For gold in particular, Matthew Cady, investment strategist at Brooks Macdonald says this is the quintessential negative-yielding asset. 

In the absence of inflationary pressures globally, as well as a moderation in recession risks following a better than expected US earnings season, he sees possible headwinds for gold.

Kevin Boscher, Ravenscroft’s chief investment officer does not believe that the UK election will have a significant impact on the price of gold in the medium-long term.

Yet, over the next few years he expects gold to move higher for a number of reasons:

• Interest rates and bond yields are set to stay very low/negative for a long time
• As central banks resume money printing, this effectively debases the underlying currencies; should governments embark on major fiscal stimulus alongside the very easy monetary stance, this will likely lead to higher nominal growth and inflation further down the road
• If the macro economic outlook deteriorates and results in either a recession or a further drop in inflation, this should be positive for gold as it also tends to perform well in deflationary times
• Gold benefits from a weaker dollar. Although we don’t expect significant dollar weakness over the next few years, it may have peaked for this cycle due to slowing US growth, a more dovish Fed and a change in investor sentiment.

 “It therefore makes sense to have some gold in portfolios as a diversification and hedge against many of the tail risks inherent in today’s markets. 

“In the near-term, the election result, together with a short-term resolution to the US/China trade dispute and further central bank reflation could result in a pick-up in investor sentiment and economic confidence over the next few months," Mr Boscher adds.

“If this scenario develops, then the gold price may soften a bit. Also, if Sterling appreciates further against the dollar, this would also lessen the attraction of gold from a sterling perspective."

Mr Boscher says that portfolios should be defensively positioned at the current time with equity exposure towards the bottom of permitted ranges and higher cash weightings than normal. 

He would also have some exposure to longer-dated treasuries / gilts for balanced or lower risk mandates as a hedge against recession/weaker growth and lower inflation. A modest exposure to gold for suitable clients also “makes sense”. 

He adds: “We cannot ignore the threat from higher inflation and should the cycle turn, this would require a different investment strategy. However, I do not expect this to happen until after the next recession and an aggressive fiscal response. 

“Within the equity exposures, it’s possible that the current period of central bank reflation will enable cyclicals and value to outperform for a period, but defensive sectors and markets should continue to generate higher returns over the long-term. 

“I also think that income will form the majority of returns for most asset classes over the next few years and that stock, sectoral and geographic asset allocation (including currencies) will also be key drivers of returns. 

“Importantly, interest rates and cash returns are very unlikely to move significantly higher for some time to come.  

"Hence, hopefully we can continue to deliver attractive relative and absolute returns for our clients through thorough research and active management, even if the market environment remains more challenging, as I expect.”