Defensive stocks have enjoyed strong enjoyed momentum since Brexit with investors flocking to companies in the tobacco, pharmaceuticals and consumer goods sectors on the back of increased uncertainty and sterling weakness. Many defensive companies’ share prices have been pushed up to multiples well above their historical averages.
However, in the last month, share price weakness has begun to appear in the defensive segment of the market, and this weakness has been exacerbated in the last week after Donald Trump’s victory in the US election.
Here’s a look at why companies such as Unilever (LSE: ULVR) and British American Tobacco (LSE: BATS) have all of a sudden lost their shine but also offer good opportunities to buy.
Inflation
With the Trump victory catching many off guard, investors have scrambled to reposition their portfolios in the last few days. Trump has promised to cut taxes and spend heavily on infrastructure and as a result, the market has come to a near-universal conclusion that inflation is likely to surge higher.
Bonds perform poorly in an inflationary environment because their ‘fixed’ interest payments are worth less to investors as inflation rises, so it’s no surprise that bonds have been sold off sharply since last week. However when bond prices fall, their yields rise. That means demand for high-yielding defensive equities, which are often viewed as alternatives to bonds for income-focused investors, can be negatively affected.
This explains why many defensives have slumped in the last few days. The market has focused on sectors that could benefit from the President-elect’s policies, rotating into cyclical stocks and leaving behind the ‘expensive defensives.’
Value appearing
So should you be worried that many key dividend stocks have fallen 10%-15% in the last month? In my opinion, no. Instead, see it as an opportunity.
Many defensive stocks such as Unilever and British American Tobacco have generated excellent returns for their shareholders over the long term so I believe these kinds of stocks make excellent core portfolio holdings.
Demand for such companies will fluctuate over time, depending on market sentiment. However, if you can build positions in high quality defensive companies when they’re offering value, it’s likely you’ll be rewarded over the long term.
Are defensive stocks now offering good value? To my mind, yes.
Take Unilever. Just over a month ago the company was trading at 3,800p. However, after a sizeable 17% fall, the stock can now be bought for around 3,150p. This means that you can now buy the stock with a dividend yield of 2.8% instead of 2.3%, quite a big difference for an income investor. While Unilever’s P/E ratio of 21.3 is still above its 10-year average of 15.1, I’d be a lot more comfortable buying the stock at 3,100p than I would be at 3,800p.
Similarly, a month ago British American Tobacco was trading at 5,100p, yet now can be bought for 4300p. That 16% fall means the company’s dividend yield has risen from 3% to 3.6% and therefore the tobacco giant is now looking a lot more attractive from an income point of view. These are just two and there are many others.
Defensive companies may have further to fall, but if you can capitalise on share price weakness, you should be rewarded over the long term.
