Is this why Neil Woodford loves tobacco and healthcare stocks?

One of the big stories of the last six months has been the high level of volatility in global stock markets. For example, the FTSE 100 was trading at 6,417 points six months ago, has been as low as 5,536 since then and is now almost back to where it started at over 6,400. Looking ahead, it would be little surprise if such volatility continued, with US interest rate rises on the horizon and Chinese growth prospects being rather uncertain.

In the face of such high volatility, predictability can be a valuable commodity. On this front, tobacco and healthcare stocks have proved popular among many notable investors, including Neil Woodford. In fact, he has said that his biggest mistake during his investment career has been to have too little exposure to the tobacco sector.

A key reason for the popularity of those two sectors could be that they’re less positively correlated to the returns of the wider index. In other words, they’re less cyclical than most of their index peers and have historically offered strong returns over a long period even if the wider economy or stock market is enduring a challenging period. For example, British American Tobacco is up by 8% in the last six months, while GlaxoSmithKline is up by the same amount during the same time period.

Certainly, those two companies are performing relatively well as businesses and this is a key reason why their shares are up by more than the FTSE 100’s 3% fall in the same time period. However, the key takeaway is that their performance could have been equally strong in a boom or a bust. They offer relative predictability over a long period since their revenue is less reliant upon the performance of the wider economy.

What’s the appeal

Tobacco is relatively unaffected by recessions or boom periods since individuals smoke regardless of their financial outlook. Clearly, they may cut back somewhat during tough times, but with global smoker numbers increasing each year and tobacco companies having tremendous pricing power, the outlook for the sector is highly appealing, even though regulations are getting tougher worldwide.

Similarly, pharmaceutical companies are reliant upon the development of new drugs in order to increase sales and profitability. Such development is less closely linked to the economic cycle than for most companies and so it could be argued that healthcare stocks provide not only the prospect of high returns, but also welcome diversification, too.

So, while buying shares in cyclical firms can mean high capital gains in the long run, tobacco and healthcare stocks could offer more reliable and consistent gains. As such, they seem to be worth buying and appear to be especially valuable during periods of uncertainty.

Of course, finding the best tobacco and healthcare stocks at the lowest prices can be challenging when work and other commitments get in the way.

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Peter Stephens owns shares of British American Tobacco and GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.