Following the S&P 500’s worst five-day start to a new year on record, investors are braced for further volatility in 2016. As a confluence of headwinds weighs on markets, including an oil price slump and China’s slow-down, Lewis Grant, Senior Portfolio Manager of the Hermes Global Equity Fund, identifies defensive stocks that he believes can thrive amid continuing market volatility.
Defensives can provide a haven of resilience in particularly choppy markets. Within traditionally defensive pockets of the market we are focusing on companies that can deliver through the cycle, with the potential to achieve strong relative performance in a downturn but who still offer enough upside to form long-term core holdings if this slump proves short-lived.
Oil slump offers effective tax break to US consumers
With potentially underwhelming US growth, a protracted China slump predicted in 2016, and oversupply issues, oil may sink towards 20 dollars a barrel. While bad news for certain energy companies, this is serving as an effective tax break for the US consumer and a major boost to low-income earners. Hence, we believe lower-end consumer outlets such as Dollar Tree and Dollar General can perform strongly in this environment.
Following the acquisition of Family Dollar, Dollar Tree has overtaken Dollar General as the number one mass-market retailer by number of locations, with almost 14,000 stores across the US and Canada. While in the short-term we expected these companies to benefit from the increased disposable income amongst cost-sensitive clientele, there remains the potential for significant expansion - Dollar Tree, for example, has a long term target of 20,000 stores.
Sentiment weighing on healthcare
Healthcare stocks tend to come to the fore when the market retreats. And while the pharmaceutical industry faces stiff headwinds, we believe fears are overblown when you consider the balance sheets and long-term prospects of a number of pharmaceutical and biotech firms.
A confluence of factors has weighed on sentiment towards the sector, including high drug prices and slow drug development cycles. However, there are some major positives such the 21st Century Cures Act which is moving rapidly through the US legislative process and will seek to promote medical innovation and accelerate drug approval process.
In the sector we like Amgen and Roche, companies straddling the pharma/biotech divide. The size of these companies, their diversified product offerings and relatively cheap valuations make them two of the most attractive Healthcare names as the market slows down. Roche in particular is interesting, being priced like a traditional pharmaceutical company but with a large and increasing biotech exposure which could command a significantly higher valuation.
Utilities offer resilience
Utilities, like pharmaceuticals and consumer staples, offer products and services that will continue to be used no matter how gloomy the economic backdrop. Unlike say the purchase of new car or appliance, utilities are essential and cannot be put off. American Water Works, the largest publicly traded water utility in the US, illustrates this idea perfectly, providing regulated water services to 20 states. The company has delivered consistent growth in recent years and has the potential to continue this through increased investment in infrastructure as well as via acquisitions. We view this company as a fantastic long-term opportunity with limited exposure to a market slow-down.
This information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
Senior Portfolio Manager, Hermes Global Equity Fund