Defensive Stocks: What to Buy During Market Downturn

The August 5 global stock market crash is a stark reminder of the importance of being prepared for potential downturns. Here’s how to prepare for the next plunge.

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The global stock market experienced a significant crash on August 5, 2024, sending shockwaves through the financial world. While markets have since recovered, the event served as a stark reminder of the importance of being prepared for potential downturns.

Understanding which stocks tend to perform well during economic turbulence can help investors protect their portfolios and potentially even profit during challenging times.

The August 2024 Crash: A Wake-Up Call

On that fateful Monday in August, markets around the world plummeted. The Nikkei index in Japan fell by a staggering 12.4%, while in the United States, the Dow Jones Industrial Average closed down over 1,000 points (a 2.6% drop). The tech-heavy Nasdaq tanked by 3.4%, and the S&P 500 sank 3%.

This sudden downturn was triggered by a combination of factors, including concerns about Big Tech’s AI investments, a weaker-than-expected US jobs report, and a surprise interest rate hike by the Bank of Japan. While the markets have since stabilized, the crash highlighted the need for investors to have a strategy for protecting their wealth during turbulent times.

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Enter Defensive Stocks

Defensive stocks are shares of companies that tend to perform relatively well regardless of the overall state of the economy. These stocks are often referred to as “non-cyclical” because they’re less affected by economic boom and bust cycles.

During market downturns, defensive stocks can act as a safe haven for investors, providing stability and often continuing to pay dividends even when other sectors struggle.

Key Characteristics of Defensive Stocks

1. Stable earnings and dividends
2. Low volatility compared to the broader market
3. Products or services with inelastic demand (people need them regardless of economic conditions)
4. Generally lower growth potential but more predictable performance

Defensive Sectors and Stocks to Consider

When looking for defensive stocks, certain sectors tend to be more resilient during economic downturns.

Consumer Staples

Companies in this sector produce essential goods that people need regardless of economic conditions. This includes food, beverages, household products, and personal care items.

In the context of the BRVM (Bourse Régionale des Valeurs Mobilières) stock exchange, which serves several West African countries, an example of a consumer staples stock could be Solibra (Société de Limonaderies et Brasseries d’Afrique). As a major beverage producer in the region, its products are likely to remain in demand even during economic downturns.

Healthcare

The healthcare sector tends to be resilient because people require medical services and products regardless of economic conditions. This includes pharmaceutical companies, medical device manufacturers, and healthcare providers.

Utilities

Utility companies providing essential services like electricity, water, and gas typically maintain stable demand and regulated pricing, making them attractive defensive options.

On the BRVM, Compagnie Ivoirienne d’Electricité (CIE) could be considered a defensive utility stock. As the primary electricity distributor in Côte d’Ivoire, its services remain crucial regardless of economic conditions.

Telecommunications

While not always classified as purely defensive, some telecommunications companies, especially those focusing on essential services, can display defensive characteristics.

Sonatel and Orange CI, listed on the BRVM, are major telecommunications providers in several West African countries. Their diverse range of services, including mobile, fixed-line, and internet, could provide some stability during market downturns.

Basic Materials

Although not traditionally considered defensive, some basic materials companies, particularly those dealing with essential commodities, can display defensive characteristics in certain markets.

SOGB (Société des Caoutchoucs de Grand-Béréby), a rubber production company listed on the BRVM, could potentially offer some defensive qualities due to the ongoing demand for rubber in various industries.

Why Invest in Defensive Stocks?

1. Portfolio Stability: Defensive stocks can help reduce overall portfolio volatility, providing a cushion during market downturns.
2. Steady Income: Many defensive stocks pay regular dividends, offering a reliable income stream even when share prices are depressed.
3. Peace of Mind: For risk-averse investors or those nearing retirement, defensive stocks can provide more peace of mind during turbulent market conditions.
4. Potential for Relative Outperformance: While defensive stocks may lag during bull markets, they often outperform more cyclical sectors during bear markets or recessions.

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Considerations and Limitations

While defensive stocks can be valuable additions to a portfolio, investors should keep a few things in mind:

1. Lower Growth Potential: The stability of defensive stocks often comes at the cost of lower growth potential during economic booms.
2. Not Immune to Major Downturns: Even defensive stocks can suffer losses during severe market crashes or economic crises.
3. Sector-Specific Risks: Even defensive sectors can face challenges. For example, healthcare companies might be impacted by regulatory changes.
4. Valuation Matters: Defensive stocks can become overvalued if too many investors flock to them for safety, potentially limiting future returns.
5. Diversification is Key: While defensive stocks can provide stability, a well-diversified portfolio should also include growth-oriented investments for long-term wealth building.

Strategies for Incorporating Defensive Stocks

1. Core-Satellite Approach: Use defensive stocks as a stable core holding, complemented by more growth-oriented satellite positions.
2. Sector Rotation: Increase allocation to defensive sectors when economic indicators suggest a downturn may be approaching.
3. Dividend Growth Focus: Look for defensive companies with a history of consistently growing their dividends over time.
4. Consider Defensive ETFs: For broader exposure, explore exchange-traded funds (ETFs) that focus on defensive sectors or strategies.

Other Tips for Investing in Defensive Stocks

1. Diversification While defensive stocks can provide stability, it’s crucial to maintain a diversified portfolio. Don’t put all your eggs in one basket, even if that basket seems safe.
2. Regular Review Economic conditions and company fundamentals can change. Regularly review your defensive stock holdings to ensure they still align with your investment goals and maintain their defensive qualities.
3. Dividend Focus Many defensive stocks offer attractive dividends. Look for companies with a history of stable or growing dividend payments, as this can provide income even when share prices are volatile.
4. Valuation Awareness Even defensive stocks can become overvalued. Be cautious of overpaying, especially if there’s been a rush to safety in the market.
5. Long-Term Perspective Defensive stocks are typically best suited for long-term investment strategies. They may underperform during bull markets but can provide stability and income over time.

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Conclusion

The August 2024 market crash served as a reminder that economic uncertainty can strike at any time. While markets have recovered, savvy investors know the importance of being prepared for future downturns.

Defensive stocks, with their stability and consistent performance, can play a crucial role in protecting wealth and generating income during challenging economic times.

For investors in West Africa, the BRVM offers several defensive options across sectors like telecommunications, utilities, and consumer staples. By incorporating these stocks into a well-diversified portfolio, investors can better weather market storms and position themselves for long-term success.

Remember, while defensive stocks can provide valuable protection, they should be part of a broader investment strategy tailored to your individual goals, risk tolerance, and time horizon. As always, it’s wise to consult with a financial advisor to determine the best approach for your unique situation.