Wall Street investors turn to defensive stocks as U.S. recession fears mount

U.S. stock investors, concerned that geopolitical uncertainty and the Fed’s efforts to fight inflation will dent economic growth, are turning to defensive sectors that they believe are better able to weather turbulent times and tend to offer strong dividends.

The healthcare, utilities, consumer commodities and real estate sectors have all posted gains so far in April, continuing their trend of outperforming the S&P 500 this year despite the broader market’s losses.

Defensive sectors have been particularly attractive in recent months as investors fear the Federal Reserve will stifle the U.S. economy as it tightens policy aggressively in response to soaring consumer prices, ie the Fed’s aggressive measures could come as they struggle to cope. The economic process leads to recession.

The Treasury market sent a worrying signal last month, with short-term yields higher than long-term yields on some maturing government bonds . This phenomenon, known as an inverted yield curve, has been around before past recessions.

The S&P 500 is down nearly 8% in 2022, with utilities up 6%, office supplies up 2.5%, healthcare down 1.7% and real estate down 6%.

As earnings season kicks off next week , reports from defensive industry companies include health care giants Johnson & Johnson, Staples and Procter & Gamble. Investors will also be watching earnings from streaming giant Netflix and electric car maker Tesla.

The Fed, which raised interest rates by 25 basis points last month, has signaled that it is ready to take even steeper rate hikes and quickly loosen its nearly $9 trillion balance sheet to bring down inflation. Investors were also rattled by geopolitical uncertainty over the situation in Ukraine, which has pushed up commodity prices and helped boost inflation.

Defensive stocks could also be “somewhat of an inflation hedge” as prices surge, said Mona Mahajan, senior investment strategist at Edward Jones.

Art Hogan, chief market strategist at National Securities, sees a 35 percent chance of a U.S. recession this year, “but that’s not our base case.”

The surge in defensive stocks has pushed up their valuations. The utility sector trades at 21.9 times forward earnings, the highest on record, and well above its five-year average of 18.3 times earnings, according to Refinitiv Datastream. The office supplies sector trades about 11% above its five-year average forward price-to-earnings ratio, while the healthcare sector trades at a 5% premium.

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