
Defensive sectors come to the fore even as investors celebrate Fed rate cut
Russ Mould Thursday, September 26
“Investors continue to welcome the first interest rate cut from the US Federal Reserve in four years, and a big one at that, in the view that the central bank is doing its best to keep American economic growth firmly on track,” says AJ Bell investment director Russ Mould.
“However, the need for a half-point cut may be tempering enthusiasm slightly, as it does suggest the Fed is concerned about the risk of a greater-than-expected slowdown, and this may be why defensive sectors are doing so well Stateside so far in 2024.
“The S&P 500 has gained just 1.6% since 10 July, which does not entirely smack of an imminent inflationary boom, and it may pay to dig beneath the headlines to see what investors are really thinking.
“The market may not always be right, but its views must be respected and so it is always worth paying attention to what the market is saying, and there will be many adherents to the view that ‘a bad stock in a good sector will outperform a good stock in a bad sector,’ at least in the near term.
“In this context, the US stock market’s response to the long-awaited reduction in interest rates from the Federal Reserve on Wednesday 18 September has been fairly textbook. Cyclical sectors such as Consumer Discretionary, Materials and Industrials have done well, as have so-called ‘bond proxies’ such as Telecoms and Utilities, as their yields become relatively more attractive as returns on cash and bond yields recede. Defensives such as Consumer Staples and Health Care have done less well, although pharmaceutical firms’ traditional role as a pre-presidential election punch bag for vote-hungry candidates could be an additional reason for the latter sector’s muted showing.

Source: LSEG Refinitiv data, as of 25 September 2024, based on S&P 500 sectors
“Tech stocks have continued to do well, and they remain the best performer in the year to date, buoyed by enthusiasm for the Magnificent Seven and all things related to artificial intelligence.
“However, the next best performer is Utilities, with Telecoms close behind.

Source: LSEG Refinitiv data, as of 25 September 2024, based on S&P 500 sectors
“This could be down to the possible boost to demand for electricity from data centres that run the Large Language Models behind artificial intelligence and store vast swathes of digitised information and content. It could be because utilities are seen as so-called ‘bond proxies,’ and a sector that usually does well when interest rates (and bond yields) are falling, as this makes the yield on utility stocks seem more attractive on a relative basis.
And it could be because investors are subtly looking for a haven, and industries where demand is relatively predictable and not too sensitive to the wider economy, just in case an unexpected slowdown is coming around the corner in the US.
“The long-term chart for Utilities’ performance relative to the S&P 500 remains ugly, but it is worth noting how the sector’s defensive, economically insensitive characteristics enabled it to outperform during 1990-92, 2000-02 and 2007-08, just as the US entered a recession or encountered some form of financial market meltdown, or both.

Source: LSEG Refinitiv data
“The presence of Financials among the leaders offers some reassurance, as does how every US sector is still in positive territory this year, but the presence of Utilities and Telecoms in the top five is not necessarily what you would expect to see if investors were truly confident in America’s economic outlook. Weakness in Energy and Materials may not be a good sign, either, although China’s efforts to reflate could yet give them a boost, especially if the US does enjoy a soft landing, or even avoid a slowdown altogether.
“According to the official data from the Office for National Statistics, the UK is emerging from the shallow recession suffered in the second half of 2023, and this may be helping cyclical sectors like Industrials and Consumer Discretionary, even if Energy and Materials are the laggards, just as they are in the USA, thanks to commodity price weakness that could speak of nerves regarding the wider, global economic outlook.

Source: LSEG Refinitiv data, as of 10 September 2024, based on the FTSE UK sectors
“That said, Materials is the best performer in the UK since the Fed cut, perhaps boosted by monetary stimulus in America, the world’s largest economy, and the application of a fiscal boost in China, its second biggest.
“Utilities have fared less well on this side of the Atlantic, and that could be down to uncertainty over the new AMP8 regulatory cycle for water companies that begins in April 2025, especially as water and waste treatment services providers are still the subject of much public opprobrium over the quality of their services, the prices they charge and the bonuses they pay. Utilities were also the subject of windfall taxes when Tony Blair’s Labour government took over in 1997 and investors may have taken some evasive action with this year’s general election in mind.
“These trends could yet prove ephemeral, and sentiment could switch again – technology for one is unlikely to go down without a fight. If indeed summer’s ructions are the first signs of a top in the sector which, for the moment at least, peaked in mid-July there may be many attempted rallies before the bull market cracks, just as there were in 2000 when the tech bubble burst. The telling indicator back then was each rally failed to reach the prior peaks and that may be a trend to note this time around, too, although investors are unlikely to be too keen to ‘fight the Fed’ for too long, unless the monetary medicine is not enough to stave off a US slowdown and the American market’s above-trend valuation multiples prove difficult to sustain (which was exactly what happened during the downturns of 2001-03 and 2007-09, when growth and thus corporate earnings both disappointed).”

Leave a Reply