Staying Even-Keeled in Equity Market Crosswinds

Stable stocks are out. Riskier reflation plays are in. But who knows which way fickle market winds will blow tomorrow? That’s why strategies that harness stability and good judgement never go out of style.

The U-turn in investors’ affections has been swift and dramatic. After more than a year of flying high, less volatile and higher-quality global stocks plunged to earth in the second half of 2016, massively underperforming the market. Cheaper (read, more cyclical) stocks took the lead (Display). The second-half sell-off in defensive consumer-staples, healthcare and utilities sectors wiped out nearly all of their collective first-half gains.

The reasons for this about-face are simple: pledges for big tax cuts, deregulation and higher fiscal spending in the US have raised expectations for global growth, inflation and interest rates. That backdrop favors financials and economically sensitive sectors, which have mostly struggled in the low-rate, low-growth postcrisis era. But it’s bad karma for the stable earners, high-dividend payers and other bond proxies that have led the market for the past several years, especially now that return-hungry investors are spotting juicier upside elsewhere.


But, as any seasoned investor knows, what the markets give, they can take away—and then give right back again. As we wrote in an earlier post, this is no time to forsake defensive investing. Signs point to more turbulence ahead. And, remember, smoother-ride strategies have a long and impressive history of outperforming the market over full cycles.

Even so, safeguarding portfolios against downside risks will require far more creativity and agility than in the past, in our view. Traditional safe-haven stocks are highly sensitive to rising rates and risk appetites. These sensitivities intensify when rates are climbing from extreme lows, a scenario that looks increasingly likely given a more hawkish US Federal Reserve. These stocks’ premium valuations amplify these risks.