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Defensive Sectors Likely to Shine for the Rest of 2022

September was historically known as the toughest month on Wall Street. This year, the performances of U.S. stock markets were more disappointing, courtesy of an ultra-hawkish Fed. The central bank has raised the benchmark lending rate by 3% year to date.

However, the Fed has failed to cool 40-year high inflation. This is because aggregate demand has remained strong owing to the astonishing savings of Americans in the last two pandemic-ridden years with unprecedented fiscal and monetary stimuli.

As the Fed has given a clear indication of the continuation of a rigorous interest rate hike and tighter monetary control, a global financial crisis looms larger. Market participants are pricing the cost of an imminent recession in stock valuation.

A Global Financial Crisis Looms Large  

The Fed has raised the median of the Fed Fund rate to 4.4% in September from 3.4% in June. This means that the range of the benchmark lending rate at the end of 2022 would be 4.25-4.5%, indicating a 75 basis-point and 50 basis-point interest rate hike in November and December, respectively.

Investors were expecting a rate cut in 2023, which is out of the question now as the central bank has projected that the median benchmark interest rate will reach 4.6% in 2023. This means another 50 basis-point rate hike throughout 2023. The first rate cut is not expected before 2024 as the Fed is expecting inflation to come down to its target rate of 2% in 2025.

As the interest rate is surging in the United States, global investors are trying to hold U.S.-dollar denominated assets to get higher returns. Consequently, the ICE U.S. Dollar Index (DXY), which measures the greenback’s strength against a basket of six major currencies, has skyrocketed to a 20-year high in 2022.

With respect to the U.S. dollar, — the British pound plunged to an all-time low, the Japanese yen is at a 20-year low, the euro is at a 20-year low and the Chinese yuan has fallen to its 14-year low. Currencies of several major emerging economies have fallen to their historic-low levels against the U.S. dollar.

Economists and financial researchers are concerned that a rising dollar will hurt the sales of U.S. multinational companies as their products will be more expensive in the international markets. Further, the volume of international trade is likely to be impacted as most of these trades are settled in U.S. dollar terms.

The yields of U.S. government bonds have soared. Last month, the yield on the benchmark 10-Year U.S. Treasury Note touched 4%, its highest since 2010. The yield on the short-term 2-year U.S. Treasury Note climbed 4.3%, its highest since 2007. The yield on the long-term 30-Year U.S. Treasury Note closed at 3.88%.

The yields of 2-year and 10-Year Notes have inverted for the last two months. After the last round of rate hike in September, the yields on 10-Year and 30-Year Notes have also inverted. Economists generally consider this situation as a sign of an imminent recession.

Why Should You Choose Defensive Stocks?

Markets are likely to remain volatile as market participants are currently assessing the possibility of a near-term recession and factorizing its financial cost into equities valuations. At this juncture, defensive sectors like consumer staples, utilities and health care should provide stability to one’s portfolio.

Defensive sectors are mature and fundamentally strong as demand for such services is generally immune to the changes in the economic cycle. These sectors include companies that provide necessities and products for daily use. Therefore, these sectors have always been a go-to place for investors, who want to play it safe during extreme market fluctuations irrespective of internal or external disturbances.

All the 11 broad- sectors of the market’s benchmark the S&P 500 Index declined year to date. However, defensive sectors like utilities, consumer staples and health care have tumbled less than the slide of aggressive sectors such as technology, consumer discretionary and communication services. Cyclical sectors namely, financials, materials and industrials also dropped more than double of the defensive sectors.

How to Select Stocks

Investors should select stocks from defensive sectors that have strong potential for the rest of 2022. These stocks must have seen positive earnings estimate revisions in the last 30 days. This indicates that the market is expecting these companies to do solid business in the rest of this year. Five such stocks are - NextEra Energy Inc. NEE, National Fuel Gas Co. NFG, General Mills Inc. GIS, Constellation Brands Inc. STZ and Molina Healthcare Inc. MOH.

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