Last week, the Bank of England set in stone that which investors have been afraid to hear. Whilst increasing the base rate to 1%, it predicted that double-digit inflation will see the UK’s economy contract by 0.25% in 2023.

While the country should avoid a technical recession (two consecutive quarters of falling GDP), Governor Andrew Bailey admitted that ‘it is a very obviously sharp slowdown in activity.’

But MPC member Huw Pill has rejected the notion that the UK is headed for stagflation, saying ‘we are not headed in that direction.’

However, Capital Economics expects the base rate to strike 3% next year, arguing that the ‘weakening economy won’t do the MPC’s job.’ And given the Bank’s inflationary track record, investors are understandably nervous about the economy’s future trajectory.

Meanwhile, Chancellor Rishi Sunak is resisting calls to increase financial support for the economy despite poor local elections results.

And as equities fall, the pound drops, and growth stalls, many investors are recalibrating their portfolios in favour of defensive stocks to combat the spectre of recession.

FTSE 100 Defensive Stocks

The widespread appeal of defensive stocks is that they usually outperform the market during recessions. Regardless of external events, their dividends, earnings and share prices usually remain comparatively stable, because they offer a product or service for which there is consistent demand. This could be because they hold a dominant market position, hold a reputation for value for money, or even provide the bare necessities.

In investor vernacular, the best stocks within defensive sectors benefit from ‘inelasticity of demand,’ making them ‘safe havens.’ If they raise prices to tackle inflation, consumers will almost always still buy the product or service.

And with UK growth grinding to a halt, increased investment in defensive stocks grants investors the ability to protect their wealth from inflation whilst minimizing their stock market risk.

Best FTSE 100 defensive sectors

Happily, for UK investors, the FTSE 100 is packed with some of the best defensive sector stocks.

First and foremost is Consumer Staples, which is the sector with companies that sells essential products and services. FTSE 100 examples include stalwarts like AB Foods, Tesco, Unilever, and British American Tobacco. Consumers will always purchase food, household products, and tobacco, regardless of financial means or the wider economic picture.

Second is the Healthcare sector. There is consistent demand for medical treatments every year, as well as financial incentives to develop new drugs. And as a consequence of the covid-19 pandemic, there is strong political consensus that FTSE 100 healthcare companies are to be backed for future preparedness. Giants GlaxoSmithKline and AstraZeneca are excellent examples.

Third is the Utilities sector. The risk-reward ratio is currently elevated as the global transition towards renewables amid climate goals and the rejection of Russian fossil fuels. But the need for electricity, gas, and water will never subside. FTSE 100 exemplars include National Grid and Centrica.

Finally, telecommunication is an excellent defensive sector, as consumer demand for mobile phones and broadband services remains consistent. While some growth may now be found from the expansion into 5G and superfast internet, demand for connectivity means that titans like BT and Vodafone are unlikely to see weakened demand, even if recession strikes.

Of course, there’s a strong argument that growth stocks, having taken a hammering so far in 2022, are now at excellent buy-in points. For example, the tech-heavy NASDAQ Composite is down 23% year-to-date. Both ARK Innovation ETF and Scottish Mortgage are in the doldrums despite previous years of outperformance. And there’s no knowing where the bottom might be.

Moreover, FTSE 100 stocks like the oil majors BP and Shell, or mining giants Rio Tinto and Anglo American, currently offer far better returns than those in the defensive sectors. However, the cyclical nature of commodities does leave investors at the mercy of demand volatility.

And as rising inflation and interest rates continue to increase the risk of a full-blown recession, the hallmark consistency of FTSE 100 defensive stocks becomes ever more appealing.

Charles Archer | Financial Writer, London
09 May 2022