Despite talk of a tech bubble, surging bond yields and extreme volatility, the equity market party is still going strong. Corporate earnings have been robust, businesses are flush with cash after US tax reforms, inflation is in check and the US economy continues to create jobs.
That’s great for equity investors, who have not seen any major downturn since the financial crisis of 2008. But when valuations are so stretched, smart investors keep their guard up in case of a correction or economic downturn.
Morgan Stanley’s equity strategists recently highlighted a risk to the ongoing rally which could be triggered by the high-flying technology names. While downgrading technology stocks to underweight from equal weight, the investment bank's analysts are now favoring defensive sectors that perform better during difficult economic times.
According to Morgan Stanley Chief US Equity Strategist Michael Wilson, it's time for technology stocks to take a back seat as the trade tensions between the US and China escalate, threatening the rich tech company valuations that depend on the world’s second-largest economy to generate sales.
The US and China slapped reciprocal tariffs on $34 billion worth of imports last week and the White House just released a list of $200 billion more in Chinese goods that could be hit. There's little doubt China will respond with some sort of countermeasures.
Morgan Stanley strategists said the tech sector may have benefited from a false sense of security over the past months. "We suspect it will not be immune from the changing attitudes toward risk assets we are seeing across markets," Wilson said in a report, cited by CNBC on its website.
How then should you balance your portfolio to shield it from markets taking an ugly turn or stalling economic growth? One solution is to diversify your portfolio with recession-proof stocks. These two businesses are built to generate cash during every economic cycle. Perhaps even better, investors can count on their dividends to be paid out regularly.
On the list of defensive names—also known as non-cyclical stocks—utilities occupy the front seat. Companies that produce power and gas for homes and offices, transport oil and gas and build storage tanks are great examples of businesses that perform well during a market downturn.
These companies are also rate-sensitive. When the Federal Reserve (or another central bank) lowers the borrowing cost to spur growth in a stalled economy, these shares outperform.
Among utilities, we particularly like Enbridge (NYSE:ENB), the largest pipeline operator in North America.
Enbridge shares are rebounding after management announced a major turnaround plan last year to help allay concerns about its high level of debt. Since then, the Calgary-based company has sold assets worth $5.71 billion to focus on its three core businesses of oil pipelines, gas pipelines and gas utilities.
The company’s regulated pipeline and utility business model is very defensive, as 96% of its cash flow is underpinned by long-term commercial contracts. Trading at $35.41 as of yesterday's close, with an annual dividend yield of 5.9%, it’s an attractive defensive buy.
Coca-Cola (NYSE:KO) is simply one of the best defensive stocks to bet on ahead of the next recession. The world’s largest beverage company owns or licenses more than 500 soft drinks including sodas, bottled water, juices and iced teas, sells its products in more than 200 countries and has 21 individual brands that generate $1 billion or more in annual sales such as Sprite, Minute Maid and Fuze Tea.
It's also the market leader across a number of its core product categories
The company has been able to increase its dividend for 56 years in a row. That's more than enough proof of the strength of the brand as well as the company’s ability to perform during recessions, market downturns and changing consumer preferences.
Earlier this year, Coca-Cola boosted its annual dividend by 5.4% to $1.56 a share from $1.48 a share in 2017. It closed yesterday at $44.79. With an annual dividend yield of 3.51%, KO shares are ideal for those wanting protection from a market slump.
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