In an environment in which recession has become one of the biggest fears for many market participants, stocks that can withstand macroeconomic shocks have become a refuge for public market investors.
Quantitative investment manager PanAgora believes that generally comes down to defensive stocks and energy companies. Defensive stocks, such as utilities and consumer staples, have lower price volatility than other public equities, are more reasonably priced, and offer better protection to investors in a market downturn. Energy stocks, which have traditionally been left out of the defensive camp because of their high volatility, are a good bet against inflation-induced recessions, according to PanAgora’s investment professionals.
“Recessions don’t happen for the same reason every time,” said Nick Alonso, head of defensive equity at PanAgora. “But in periods where you had inflation take off, like in the 1970s, energy was a piece of headline inflation, so it was the first area of the economy that saw price increases during inflationary periods.”
George Mussalli, chief investment officer at PanAgora, added that quality stocks with strong balance sheets — which usually fall into the defensive category — are also good investment targets during market drawdowns. “You need to have a good positioning in the industry to be able to withstand the forces of inflation and also pass along the increases in your costs to consumers,” he told II in an interview.
According to Alonso, energy stocks could play a spectacular role as a nontraditional defensive position. “In our philosophy at least, you really need to represent the entire world or the entire market in a defensive portfolio,” he said. That means adding the inflation-sensitive energy stocks that have taken a big share of the market. “Maybe that looks like a different type of portfolio, but it really did provide a lot of defense at the beginning of the year.”
Mussalli said that growth stocks, which had a good run before 2022, tumbled into bear-market territory recently because their future cash flows are worth less in a high-inflation environment. On the other hand, stocks with high dividend yields “are just throwing up cash today,” he said. Dividend stocks could be especially valuable with rates rising and fixed income disappointing. “Even if inflation is high,” he added, “it’s not going to impact [dividend stocks] that much.”
The market conditions for high-growth equities won’t improve for at least the next one to three years. “Inflation [is] going to be with us for a while, and it will remain elevated and tough to crack,” he said. “There’s a lot of excesses that have begun to correct, but there’s a long trail going forward.” Asset manager GMO also predicts that the worst is yet to come for growth stocks.
Mussalli said that credit conditions are also a major concern. “When you have high inflation and tightening credit conditions, you want moderately priced stocks, strong balance [sheets], and high quality, which is also a brand of defensive [positioning].”
