Another look at the defensive sectors in the U.S.

The performance of your stock portfolio will be shaped by your geographic weighting, but mostly by your sector allocation. Certain sectors are more growth oriented. Other sectors are more defensive. Some sectors can prosper during inflation while for others, inflation or stagflation is the kiss of death. On the defensive front, consumer staples, healthcare and utilties lead the way. And while we might underperform the market by way of a defensive portfolio stance, healthcare is known to also possess a solid growth streak. DataTrek recently provided an interesting look at the defensive sectors in the U.S.

Of course, there is a time to play offense and a time to play defense. If you are young with decades to go in the accumulation stage, you should seek growth. Look for growth-0riented markets such as the tech-heavy U.S. market (IVV). You might even slant to more growth-oriented funds such as the Nasdaq (QQQ). You may also look to mid cap (IJH) or small cap stocks (IJR) or emerging markets (EEM). When possible you might select stocks from those sectors. There are many growth options.

In Canada we might look to tech and the big dividend paying stocks or build around the Beat The TSX Portfolio.

Playing defense

In retirement, or if we are within the retirement risk zone, we might benefit by playing some portfolio defense. In place of growth at all cost, holding a portfolio that has lower volatility has its benefits. It will reduce the sequence of returns risk. It may also lead to greater and more stable income.

I recently had a look at defensive strategic sector allocation in the all-weather portfolio for U.S. investors. The strategy can also be applied by Canadian investors as we can access these sectors by way of U.S. listed ETFs. There are also Canadian dollar ETF offerings.

Consumer staples and healthcare stocks can thrive in many economic environments. They can also be much more recession-proof. Even in troubling economic times, we still need to buy the essentials. We still need to take care of our health. These sectors themselves are more all-weather.

Healthcare – defense and growth

DataTrek shared some interesting research (via email). US large cap Utilities, Consumer Staples, and Health Care are all outperforming this year. And one can draw a direct line between how stable their businesses are and by how much they have beaten the index:

• S&P 500: -6.7 percent
• Utilities: +6.2 pct
• Consumer Staples: +2.3 pct
• Health Care: -1.1 pct

DataTrek analyzed whether Utilities, Staples and Health Care are outperforming by a normal amount for this part of a market cycle. They pulled the last 21 years’ worth of annualized relative return data for each sector (how each group performed versus the S&P 500 over the prior 253 trading days, from 2002 – present). 

This is what they found. Remember, standard deviation measures the risk/volatility.

Playing defense over the last year

Utilities:

• Average annualized relative performance vs. S&P (2002 – present): -2.8 percent
• Standard deviation of relative returns: 12.4 percentage points
• Last 12 months outperformance: +9.9 percent, just over 1 standard deviation (9.6 percent) from the long run mean

Consumer Staples:

• Average annualized relative performance vs. S&P: -2.2 percent
• Standard deviation: 10.2 points
• Last 12 months of outperformance: +7.6 pct, just less than 1 standard deviation (8.0 percent)

Health Care:

• Average annualized relative performance vs. S&P: +0.7 percent
• Standard deviation: 9.5 points
• Last 12 months of outperformance: 10.7 percent, just over 1 standard deviation (10.2 points)

We see that consumer staples are the uber defensive sector and will deliver very good returns, but can underperform slightly (not an issue for a retiree). Ditto for utilities. Meanwhile, healthcare offers that defensive stance while also delivering a growth tilt. And given aging populations, the trend for healthcare might be even more favourable moving forward.

From DataTrek:

Takeaway: we like Health Care as a defensive play here. Nothing against the other two options we’ve discussed today, but Health Care has better long-term growth opportunities. That is why it is the only one of the 3 sectors to outperform since 2002.

Personally, I’d be a fan of putting all of the defensive sectors to work, and perhaps in equal-weight fashion. I have been adding to a few healthcare and consumer staples stocks. They will pair up nicely with my telco stocks (BCE.TO) and Telus (T.O) that represent modern utilities. You may choose to overweight to healthcare that appears to be the full package on the defensive front line.

With a recession on the way 😉 I wish my portfolio was 10% Walmart $WMT

— CutTheCrapInvesting (@67Dodge) April 13, 2022

Yes, notice the wink in that tweet. No one knows when the next recession will arrive, but I am happy to play more defense just the same. That said, I did not kick all growth to the curb. I have maintained my growth component in my personal account. New monies and portfolio income have been directed towards defense. I have trimmed some tech holdings in my wife’s accounts (over the last year and more).

Playing defense in the last major correction

Here’s a look at the defensives (Healthcare, Staples, Utilities) vs the market during the financial crisis correction of 2008-2009. The defensives are equal-weighted.

We also see that an investor outperformed by way of defense, through the last two corrections (financial crisis and the COVID correction).

The drawdown in 2008-2009 was considerably less (30% or so) compared to the S&P 500. That can be a considerable benefit to the retiree and the more risk-averse investor.

Of course every correction is different. On Seeking Alpha I have looked at sectors and market corrections. Here was a scorecard taking into account the dot-com crash (early 2000’s) and the financial crisis.

If the next corection or recession is caused by the oil price and commodities spike, we’ll likely see Energy and Materials move towards the top of the list. That said, they might be joining Staples and Healthcare. Readers will know that we also have some solid energy and commodities exposure.

Our portfolios have an all-weather stance, but again, I am adding more defense.

The full sector scorecard in the 2000 COVID correction

1. Discretionary (XLP) down 25%
2. Staples (XLV) down 30%
3. Materials (XLB) down 31%
4. Healthcare (XLY) down 34%
5. Tech (XLK) down 36%
6. Utilities (XLU) down 39%
7. REITs (XLRE) down 41%
8. Industrials (XLI) down 44%
9. Financials (XLF) down 44%
10. Energy (XLE) down 65%

The S&P 500 was down by 35% in the correction.

Discretionary stocks can also be a consideration. They have a solid history in the last 3 corrections.

Adding healthcare, consumer staples and utilities

In Canada, you’ll find many healthcare ETFs. You might use Canadian utilities stocks or ETFs, or seek a U.S. option. You can use a Canadian staples ETF, though it might be wise to undo some of any Canadian home bias and look for a U.S. or International option.

Please add more options in the comment section. You might share your favourite stocks in each sector as well. Thanks for reading and sharing.

As always, make sure you understand the risks, and tax implications. Ensure you have that greater financial plan.

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