Chart of the Week - Defensive Diversifiers
An overlooked and under-allocated cheap diversifier with technical tailwinds...
Defensive stocks are gearing up for a potential repeat of a once-in-a-decade move
…and there are bigger implications than just the opportunity it represents.
Defensive stocks (Consumer Staples, Utilities, Healthcare) have a habit of outperforming when the market falls. They are boring reliable dependable businesses, often with mature and stable cash-flows that often just tick along no matter what the economy is doing.
That means they lag behind and underperform when everything else is doing great, but serve as an important portfolio buffer in a downturn.
And whatever your view is on the current correction (e.g. a healthy reset vs the start of a larger downturn), the setup for defensives is pretty interesting…
They are trading at the third cheapest point since 1973 on a relative value basis.
Investor allocations are ticking up from record lows.
Technicals are starting to turn up (relative performance, breadth); and
We are currently in the middle of a seasonally strong patch for defensive assets (through to November).
So defensive stocks look good!
And that’s kind of bad…
If you take a look at the chart below, it shows the relative performance of the defensive sectors vs the S&P500 — defensives trough when the market peaks, and surge when the market rolls over into a crash/correction/bear market.
The bad thing is that if you are sitting here saying that defensive stocks look good, then by implication you’re indirectly also saying that the outlook for the S&P500 index is *not* good.
Indeed, it’s when the relative performance line gets significantly stretched to the downside like it is now (and like it did in 1980, 2000, 2021) that the risk of a market downturn rises.
On the flipside, when it surges and spikes to an extreme, that serves as an alternative source of information on the bull side — a buy signal (e.g. 2022, 2020, 2016, 2009 1991, 1982) …so that’s something to think about for later if we do get into a deeper downturn.
But in the immediate term, it’s a good prompt to have a think about your diversifiers. Bonds probably will perform well in a recessionary downturn, but 2022 taught us bonds are no sure thing. Gold or oil/energy stocks can likewise serve a function as a hedge or diversifier but only in certain macro regimes.
Ultimately what you want to do is understand how your proposed hedge or diversifier is going to perform in certain macro/market environments, but also understand the valuation situation and wider setup (which again, is looking good for defensive stocks). In my view you want to be an intelligent diversifier — use smart diversification so that you avoid dud-diversifiers (like bonds in 2022), and seek out undervalued diversifiers (commodities, in 2021 and into 2022).
Defensives may well be the next smart diversifier (as a relative play).
Key point: Defensive stocks look good (and that’s kind of bad).
Topdown Charts Pro — Global Macro/Market Intel
Established in 2016, the Topdown Charts institutional service has become a trusted source for some of the world’s largest fund managers. Access the reports now.
The service was designed specifically for active asset allocators and those who require high quality top-down insights in their investment process. The reports are easy to read and focus on charts + data over opinion — yet at the same time you are never left guessing on what we think or how the puzzle pieces fit together.
Check out the Topdown Charts Professional service to see how it can help you!
Topics covered in our latest Weekly Insights Report
Here’s what we covered in the entry-level service here:
Market Update: global equities, fixed income, currencies, commodities
Defensive Stocks: update on technicals/valuations/positioning
Correction Check: next steps as we navigate the next downturn
Credit Spreads: what to track as spreads start to widen
Commodity Equities: what’s up with commodities
US Housing Market: reviewing the outlook and risks
Subscribe now to get instant access to the report so you can check out the details around these themes, as well as gaining access to the full archive of reports.
For more details on the service *check out this recent post* which highlights:
a. What you Get with the service;
b. the Performance of the service (results of ideas and TAA); and
c. What our Clients say about it.
But if you have any other questions on our services definitely get in touch.
Thanks for your interest. Feedback and thoughts welcome.
Sincerely,
Callum Thomas
Head of Research and Founder at Topdown Charts
Follow me on Twitter
Connect on LinkedIn