Five defensive sectors to own in 2023

A heavyweight investment bank gives its view on where investors should be focusing in the months ahead.  

Key takeaways from a City bank’s look ahead to 2023 include recommendations that investors stay defensive and are underweight cyclicals during the first part of the year.

Bank of America is also cautious on financial stocks due to the outlook for lower bond yields and advises being underweight on resources as commodity prices look set to weaken.

The strategy for investors in Europe is built around expectations for a sharp loss of global growth momentum before a cyclical recovery, as the drag from monetary tightening wears off and China reopening kicks in from the middle of the year.

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The bank’s analysis anticipates a near-term reversal in the recent trends that have seen European cyclicals outperform defensives by 15% since July, a rally aided by a sharp acceleration in US output growth in response to easing supply constraints.

The bank said: “We think the growth strength will prove temporary, as a sharp roll-over in the US and the euro area credit cycle in response to aggressive monetary tightening in combination with the fall-out from the latest Covid wave in China, lead global growth momentum to weaken into the first half.”

Projections for credit spreads to widen as a result of the rising recession risks should make defensive sectors more attractive, while weighing on financials. This means the bank is overweight on food and beverage as well as pharmaceutical stocks.

The food & beverages and personal & household goods sectors outperformed by around 15% from January to September, only to fall back as improved growth perceptions tipped the balance back towards cyclical stocks.

The bank’s forecasts imply a 12% upside relative to the market, with a projected peak in the second quarter followed by a pull-back into the year-end as a trough in the macro cycle opens the path for renewed cyclical outperformance.

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While defensive sectors such as pharma and food & beverages trade on high price/earnings premiums, the bank said consensus projections do not yet fully reflect these sectors' likely earnings outperformance in response to recessionary dynamics.

The bank added: “Around the recessions of 2001, 2008 and 2020, the median increase in 12-month forward EPS relative to the market was close to 40% for pharma and more than 60% for food & beverages.”

It is also overweight utilities, expecting recession worries to drive outperformance, and on software given the boost from declining real bond yields.

Energy outperformance this year has been driven by a combination of spiking oil and gas prices, surging real rates and the impact of a weaker pound.

However, Bank of America believes all three factors are turning into headwinds, with oil and gas prices down sharply from their peaks, real rates starting to fade and the pound recovering.

It said: “Energy has started to underperform and the further oil price weakness we expect on the back of slowing growth implies further underperformance ahead, while our view of fading copper prices on China lockdowns underpins our underweight in mining.”