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Tech stocks now defensive, growth stocks becomes value


Stylistic investing, or the concept of separating companies into arbitrary buckets due to the perceive growth, value or defensive characteristics tends to dominate discussions these days. Fundamental research and the many rules of thumb applied by investors were founded in a very different world where ‘cigar butt’ companies proliferated and the way we work wasn’t being disrupted on a daily basis.

In responding to the fast-evolving world we now live in; US$2 trillion asset manager Capital Group has been educating investors on the so-called “New Defensives” in markets.

The concept of a defensive stock is straightforward, it typically means a company with resilient earnings and which isn’t exposed to the vagaries of markets like economic growth, commodity prices and inflation. More specifically according to Capital Group “defensive stocks and sectors are ones that have been able to retain value despite economic upheaval”. 

  • In their recent White Paper, they highlight the fact that 2020 saw significant headwinds for traditional defensive companies, like healthcare, transport and consumer staples businesses. Value and high dividend stocks have traditionally been seen as defensive with their income a key source of return amid volatility, yet with dividends quickly cut during the pandemic they may not be the long considered safe havens anymore.

    Many of the world’s fastest growing companies have actually exhibited more defensive quality in 2020, by virtue of the swift embrace of the digital economy and a number of key secular growth areas. In response to an incredible, the author asks the question “are traditional defensive sectors safe?”; the answer is not what you would expect.

    Sectors such as utilities and consumer staples have historically held up better than the market. However, “seeking defensiveness simply by investing in such sectors may not be such a wise strategy” according to Capital Group, “each market downturn is different” they say and “certain sectors will be more impacted than others”. The perfect example was the difficulty faced by the tech sector in the dotcom crash, but resilience in 2020’s selloff.

    As has been on show throughout 2020, active management is key, highlighted by the fact that “volatility at the sector level may ignore significant differences in returns within a sector”, with the huge dispersion in returns highlighting the importance of fundamental research.

    Now if relying on broad sectors is no longer ideal, what broad themes should investors be turning to? The answer is those with “the potential to unlock large addressable markets and drive secular growth” like video streaming, social networks and video games. According to an Ipsos survet, millennials check their phone 50 times per day and spend 53 hours of their time online, suggesting “demand for tehse services could end up displaying similar traits to utilities”; Next Generation Utilities as Capital Group refers to them.

    Finally, they highlight the “new breed of defensive companies” established new business models, with their innovative strategies likely to help boost earnings; think software-as-a-service. The authors highlight Microsoft as a key example of a company embracing a subscription-based model, delivering business-critical products that benefit both suppliers and consumers. “This greater accessibility of software, at more attractive pricing models, is helping such products and services to become a staple for the businesses that use them” they suggest.

    With every announcement, earnings update and product released covered within an inch of its life, investors are being forced to seek an edge through analysis. An unconventional mindset when assessing business models may well be the edge we are all seeking.

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