NEW YORK — Fresh volatility in U.S. stocks is prompting some investors to focus on sectors of the market that have performed well during a difficult year for equities, such as energy stocks, defensive stocks, and dividend payers.
The S&P 500 has fallen 9% since mid-August, partially reversing a summer rally after Federal Reserve Chairman Jerome Powell warned that the central bank’s zealous fight against inflation could cause economic harm.
While few sectors of the market have escaped the index’s nearly 18% drop this year, some have fared comparatively better, a dynamic that investors hope will mitigate further losses in their portfolios if asset prices remain volatile.
Consumer staples, healthcare, and utilities have fallen less sharply than the broader S&P 500 this year. During uncertain times, investors gravitate toward companies in these sectors, expecting consumers to continue spending on medicine, food, and other necessities despite economic turmoil.
Despite a recent pullback, the energy sector remains one of the biggest winners of 2022, with a 44% year-to-date gain.
Simultaneously, the S&P 500 dividend aristocrats index, which tracks companies that have increased dividends annually for the past 25 years, has fallen about 10% this year, a less severe decline than the overall market decline.
“Those types of steady Eddie names could tread water in a downward sloping market,” said Chad Morganlander, portfolio manager at Washington Crossing Advisors, who manages a strategy that includes companies such as Johnson & Johnson and Clorox Co. that he expects to increase dividends in the coming months.
The S&P 500 finished the week down 3.3%. The index fell 1.1% on Friday, as early gains from a U.S. jobs report indicating a labor market that may be loosening gave way to concerns about the European gas crisis.
The rally that has propelled stocks for the majority of the summer has taken a significant hit, with the S&P 500 now up about 7% from its mid-June low. If the index makes new lows this year, it will be the fourth time stocks have gained at least 6% before falling and marking a new bottom for 2022.
Bond yields have quickly recovered, complicating the outlook for equities and putting technology and other growth stocks that are more sensitive to rising yields under particular pressure.
“The pullback in equities… and the rise in yields are consistent with our view that investors underestimated central banks’ willingness to tighten policy at current inflation rates,” UBS Global Wealth Management wrote this week.
Portfolios should be skewed toward defensives, such as pharmaceutical stocks, and so-called quality companies, which have higher-than-average dividend yields and low debt-to-equity ratios.
Concerns that the Fed will struggle to control inflation, which has risen at its fastest rate in more than four decades this year, have prompted investors to diversify. A 20% increase in Brent crude has helped make energy stocks a favorite this year, while also putting upward pressure on consumer prices.
“I am not convinced equity investors fully understand the impact of inflation on their portfolios,” said John Lynch, chief investment officer at Comerica Wealth Management, citing the economic consequences of higher interest rates and the erosion of profit margins due to higher costs.
He has recently purchased more shares of energy companies, betting that supply constraints will keep oil prices high. Lynch has also purchased shares in the healthcare sector, which he believes is less expensive than other defensive sectors of the market.
Of course, the areas that have outperformed this year have their own set of risks. Energy prices have been volatile, and a recession could reduce global demand, putting pressure on energy stocks.
Some defensive sectors, notably utilities and staples, are trading at significantly higher price-to-earnings multiples than their historical averages. If the economy avoids a downturn, investors may abandon defensive investments.
Horizon Investment Services owns utility stock, but “we’re not just playing defense,” according to Chuck Carlson, the firm’s CEO.
“Some of those areas are quite pricey,” Carlson said. “You’re footing the bill for that defense.”
