Defensive sectors are off to a better start to the new year than growth stocks, which dominated in 2023.
The Health Care Select Sector SPDR Fund (NYSEARCA: XLV), which has both growth and defensive characteristics, was the leader in the first week of the year. Top sector performers included Moderna Inc. (NASDAQ: MRNA), Merck & Co., Inc. (NYSE: MRK) and Viatris Inc. (NASDAQ: VTRS).
Energy stocks, consumer staples and utilities stocks, all traditional defensives, rounded out the list of those starting the year with gains.
In the Energy Select Sector SPDR Fund (NYSEARCA: XLE), top performers at the beginning of the year were Marathon Petroleum Corp. (NYSE: MPC), The Williams Companies, Inc., (NYSE: WMB) and Exxon Mobil Corp. (NYSE: XOM).
Utilities Select Sector SPDR Fund (NYSEARCA: XLU) leaders were Pinnacle West Capital Corp. (NYSE: PNW), FirstEnergy Corp. (NYSE: FE) and Xcel Energy Inc. (NASDAQ: XEL).
Within the Consumer Staples Select Sector SPDR Fund (NYSEARCA: XLP), The Hershey Co. (NYSE: HSY), Altria Group Inc. (NYSE: MO) and Sysco Corp. (NYSE: SYY) led the pack.
Defensives rotating into leadership?
In years following the dominance of growth stocks, as we saw in 2023, it’s not uncommon for defensives to rotate into leadership.
This shift can occur as investors reassess their risk tolerance and seek stability amid economic uncertainties, plenty of which remain in 2024, despite inflation easing and the job market remaining robust.
Defensive sectors, including utilities and consumer staples, become more appealing due to their lower volatility, as well as reliability when it comes to dividends.
In years when defensive stocks take the lead, the S&P 500 tends to reflect a preference for stability and income amid economic uncertainties. These years are marked by characteristics such as:
- Lower Overall Returns: Defensive stocks are known for their reliability in uncertain economic conditions, yet they contribute comparatively lower overall returns for the S&P 500.
- Interest Rate Sensitivity: Defensive stocks are particularly sensitive to interest rate movements, although that’s true of some growth sectors as well, such as the Technology Select Sector SPDR Fund (NYSEARCA: XLK). If rates are cut in 2024, as expected, dividend-paying defensive stocks may become more attractive.
- Market Rotation: A leadership role by defensive stocks often signifies a rotation away from high-beta sectors like tech, communications or consumer discretionary. This shift happens as investors favor assets perceived as more stable during challenging economic environments.
So what are defensive stocks exactly? They’re definitely not as glamorous as techs, and don’t show the kind of sky-high rallies of a stock like Nvidia Corp. (NASDAQ: NVDA), which returned 240% in 2023.
Defensives can rally even as AI innovation continues
It sure looks like Nvidia will rule the roots among artificial intelligence stocks for the foreseeable future, but that doesn’t negate the thesis that less volatile stocks may do better in 2024 than in 2023.
Defensive stocks typically outperform during economic downturns. That’s because they belong to industries providing essential goods and services. Think about that: In a recession, people won’t stop seeking medical care (especially if they have good insurance). They won’t stop buying shampoo and toothpaste. They won’t stop filling up their cars to get to work, although they may put off that electric vehicle purchase.
As an additional draw, many defensive stocks offer regular dividend payments, providing investors with a consistent income stream. The reliability of sales regardless of an economic cycle contributes to these companies’ ability to continue returning capital to shareholders through dividends.
Checkup on healthcare stocks
While Moderna, Merck and Viatris are the best performers among healthcare stocks, they’re also the S&P 500 leaders in the first week of January.
There are reasons to be cautious, as well as optimistic about healthcare stocks in 2024.
On the cautionary side, healthcare stocks often underperform in presidential election years, as investors become concerned about possible regulatory changes that could put a dent in earnings. Already, Medicare drug price negotiations are on the horizon, which could affect companies including Merck, AstraZeneca PLC (NASDAQ: AZN), Bristol Myers Squibb (NYSE: BMY) and Johnson & Johnson (NYSE: JNJ).
However, beaten-down subindustries, such as medical device makers and biotech may be poised for a rebound.
