What Is a Defensive Buy?
A defensive buy is the purchase of defensive stocks—securities or investments that are perceived as being lower risk by their lower exposure to economic cycles. While the term is generally used in connection with stocks that possess defensive characteristics, such as stable cash flows and lower volatility, it may also be used to refer to lower-risk securities, such as government bonds and preferred shares.
Defensive stocks may outperform their flashier counterparts, like growth stocks, during periods of economic uncertainty when equity markets display a declining trend but will underperform during periods of economic expansion.
- A defensive buy is the purchase of defensive stocks—securities or investments that are perceived as being lower risk by their lower exposure to economic cycles.
- Defensive stocks may outperform their flashier counterparts during periods of economic uncertainty when equity markets display a declining trend.
- However, defensive stocks will usually underperform during periods of economic expansion.
- Savvy investors with diversified portfolios will tend to overweight defensive stocks during slow or no growth periods and underweight them during expansionary periods.
Understanding a Defensive Buy
From an equity perspective, defensive buys are usually found in sectors that are immune to recessions and economic slowdowns. These sectors generally comprise suppliers of essential goods and services—such as pharmaceuticals, utilities, and consumer staples—that consumers cannot forgo even during difficult economic times. Even in recessionary periods where consumer spending is likely to decline overall, most people will find a way to budget for soap, toothpaste, food, and other everyday essentials.
While a defensive buy may offer the substantial benefit of similar long-term gains with lower risk than other stocks, the low volatility of defensive stocks often leads to smaller gains during bull markets and a cycle of mistiming the market. Savvy investors with diversified portfolios will tend to overweight defensive stocks during slow or no growth periods and underweight them during expansionary periods. Such investors will also attempt to anticipate and identify economic inflection points, and tweak their portfolios accordingly. Gross Domestic Product (GDP) is widely viewed as a reliable indicator of a country’s overall economic health.
An expansive list of defensive sectors with sub-categories includes the following:
- Financial Services: Mortgage Real Estate Investment Trusts (REITs), life and health insurance companies, banks, capital markets.
- Healthcare: Healthcare providers and services, healthcare equipment and supplies, healthcare technology, life sciences tools and services, biotechnology, pharmaceuticals.
- Industrial Sector: Building Products, aerospace and defense, machinery, construction and engineering, industrial conglomerates, electrical equipment, airlines, roads, railroads, air freight and logistics, commercial services and supplies, trading companies, and distributors.
- Real Estate: Real estate management and development, Equity Real Estate Investment Trusts (REITs)
- Technologies: Software, IT services, Internet software, Internet services, communications equipment, storage and peripherals, technology hardware, electronic equipment, semiconductors, and semiconductor equipment.
- Utilities: Multi-utilities, gas utilities, electric utilities, water utilities, independent power, and renewable electricity producers.
- Food and Staples: Retailing, food products, beverage products, household cleaning products, personal hygiene products.
- Basic Materials: Chemicals, containers and packaging, construction materials, paper and forest products, metals, and mining.