It may be time for investors to change course.
on the other hand,
Nasdaq Composite Index
Stocks have hit record highs, buoyed by investors enthralled with big tech stocks like Nvidia and other artificial intelligence names, but some experts see a shift coming. With central banks around the world preparing for interest rate cuts and a possible economic slowdown, they say it makes sense to consider more defensive sectors.
We’ll explain what’s going on and what to do about it.
“After an extended period of weakness, defensive stocks are beginning to trade better,” JPMorgan equity strategists wrote in a report on Tuesday. “If bond yields are declining amid slowing economic growth, sector leadership is likely to shift more toward defensive positions.”
As expected, the yield on the 10-year Treasury note has plummeted from just over 4.7% at the end of April to around 4.53% today. First-quarter gross domestic product (GDP) growth was just 1.6% on an annualized basis, below the 3.4% recorded in the final three months of 2023. (The government will release revised figures on Thursday.)
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With this in mind, JPMorgan strategists said they are currently recommending an “overweight” stance on utilities, real estate, healthcare and consumer staples stocks globally.
All four of these sectors are known for their high dividend yields, tend to benefit when interest rates fall, and offer relatively attractive dividends. Utilities have been a market darling lately as a company that could benefit from AI’s robust demand for electricity, but the other three sectors have lagged the overall market rally this year. Real estate stocks are actually down 7%., The S&P 500 is up 11%.
These sectors may finally see buying once it becomes clearer when the Fed will cut interest rates. Signs of economic weakness, which in itself can influence monetary policy easing decisions, may also help.
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Currently, the Fed is expected to begin cutting rates before there is significant evidence of economic weakness. However, if the Fed is too late to halt a recession, defensive sectors could come back into the spotlight. Keep in mind that the Fed has raised rates 11 times between March 2022 and July 2023, and it may take months for those hikes to have their full effect.
“Yield alternative sectors remain attractive due to their defensive characteristics as a hedge against a recession,” Ross Mayfield, investment strategy analyst at Baird Private Wealth Management, said in a recent report.
The defense sector is not the only investment that could thrive during an economic slowdown.
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JPMorgan strategists also said they favor commodities as part of a so-called barbell approach, balancing cyclical stocks with more defensive-minded names.Precious metals, led by gold and silver, have been rallying recently. Copper has also rallied on hopes of an AI boom and an economic recovery in China. Copper wire is the best conductor of electricity and is a key component in utilities and data centers.
Small caps may also be attractive buys if the Fed and other central banks start easing monetary policy. JPMorgan strategists are a little more optimistic about European small caps, arguing that “signs of a turnaround may be on the horizon, given upcoming rate cuts from the ECB and Bank of England.” With no clear indication of when the Fed will start cutting rates, it may take some time for U.S. small caps to recover.
But some fund managers are still betting on an early rate cut, saying small-cap stocks should rally and perhaps outperform their larger peers once borrowing costs start to fall.
The Fed’s rate hikes have hit small-cap stocks harder than large ones, dragging down earnings expectations and stock prices, said Bob Scott, a portfolio manager at Next Century Growth. He said the rate cuts should enable small-cap stocks to achieve higher earnings growth.
“Small caps have digested the last few years of rate hikes and are now trading at more reasonable valuations,” Scott said. “Small caps should typically grow faster than the average large cap, and historically they have performed well when the Fed has cut rates.”
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The RiverPark/Next Century Growth fund, run by Scott and a team of managers, holds small-cap stocks with growth potential but leans a bit defensively with a focus on health care. Key holdings include RXSight, which makes adjustable intraocular lens implants for cataract surgery patients, and Tandem Diabetes.
,
Insulin pump manufacturer.
These companies and other defensive stocks may not have the same appeal as Nvidia and other AI names, but investors need to start building their portfolios for low interest rates and slowing growth before it’s too late.
Write to Paul R. La Monica at paul.lamonica@barrons.com
