While most companies have both defensive and cyclical attributes, and these can vary over time, cyclicals typically display more volatility as expectations of the economy change, while defensives are usually steadier and less likely to rise or fall rapidly, said Morgan.
However he said many fund managers have been telling Charles Stanley defensive stocks are comparatively expensive compared to cyclicals, likely owing to the prevailing interest rate environment: “With rates at all-time lows investors have been forced into higher risk asset classes such as equities to maintain the same level of income. Defensive equities with stable and rising dividends have become a target for yield-hungry investors who might not otherwise consider the stock market at all.”
This trend also means defensives could be particularly vulnerable if the market falls due to a sudden rise in interest rates, in Morgan’s view. “It is food for thought. When buying defensives investors should be aware of what they will and won’t defend against. While good at guarding against a stalling economy their solid characteristics may disappear when presented with rising interest rates.”
This, said Morgan, was illustrated in the summer when markets fell as comments from Ben Bernanke, US Federal Reserve chairman, on quantitative easing were interpreted as a sign interest rates might soon rise. Some of the more defensive areas took a significant hit before recovering as fears were assuaged.
Morgan highlights funds such as the M&G Global Dividend fund, managed by Stuart Rhodes, which currently have more cyclical holdings in the portfolio on the basis they represent better value overall, and could provide rising profits and dividend growth if the economy gathers pace.
