10 top defensive stocks for volatile markets

The UK's vote to leave the European Union (EU) has caused severe volatility in parts of the stockmarket. Gripped by uncertainty, some companies and sectors have been hit hard as a result of investors rushing for the exit. But not all shares have suffered. In fact, a number of defensive stocks have weathered the choppy conditions rather well. It's a lesson on why diversification between sectors can offer some protection in turbulent times.

Ahead of the EU referendum, speculation was rife about how share prices might react to the result. As it turned out, a vote for Brexit immediately cast a shadow over those with any hint of a reliance on European trade and domestic consumer confidence. Some of the biggest losers have been banks, housebuilders, retailers and recruitment firms.

Investors are well-versed on the damage that uncertainty can do in equity markets. Political and economic instability and the risk of recession mean that stocks sensitive to economic cycles can fall sharply when the outlook is bleak. Generally, the most susceptible companies can be found in sectors like basic materials, consumer cyclicals, industrials and technology.

On the flip-side, stocks that tend to fare better in the face of wavering economic sentiment include consumer defensives, healthcare, telecoms and utilities. Two other major sectors - energy and financials - don't easily fit in either category. But shares in those sectors can also rise and fall sharply depending on the prevailing conditions.

What makes a defensive stock?

Defensive sectors are often regarded as safe-haven territory for investors. Their companies are prized for having revenues, earnings and dividends that stay robust through the economic cycle. They do it by providing goods and services that customers will always buy, despite how rich or poor they feel. It could be anything from toothpaste to a packet of cigarettes.

The trade-off with defensives is that they don't tend to rise as sharply as cyclicals in prosperous times. But when clouds gather on the horizon, defensives don't generally fall as hard as cyclicals either.

Another steer worth thinking about when it comes to looking at defensive stocks is to consider something called low "beta". Beta is a measure - often taken over several years - of how sensitive a stock price is to the movement of the wider market. It's a key component in what's known as low-volatility investing.

If a stock price tends to rise more than the market on up-days and fall more than the market on down days, it will have a beta greater than 1. But if it isn't as sensitive to market movements - rising, or falling, less than the market - then it will have a beta of less than 1.

It wouldn't give you the full picture of volatility, but it can be used as a risk indicator to show how exposed your portfolio is to riskier stocks. Plus, it's worth remembering the not all stocks in defensive sectors have low betas.

In periods of volatility, buying stocks needs calm, considered thinking and research. So this week's top 10 stocks is really an example of how to start looking for shares that might be suited to a defensive portfolio - normally before uncertainty strikes.

It's a FTSE 350 list that looks at the forecast dividend yields in defensive sector shares, as well as their compounded annual earnings growth rates over the past three years. They needed to be low-beta stocks where earnings forecasts have been upgraded recently.

Crucially, some of these shares have seen their prices come under pressure during the recent market chaos - but often not as badly as many cyclicals. Some of those include SSE, AG Barr, Synthomer and RPC.

But others have been much more robust. Stocks like Imperial Brands, Unilever, Johnson Matthey and Reckitt Benckiser have held up reasonably well. In the circumstances, it appears that defensive groups that derive a good chunk of revenues from foreign markets have been better protected.

When defence is the best offence

Trading shares in the eye of a storm can be perilous. But for those investors nursing heavy paper losses, it may well be worth thinking about whether sector diversification could offer better protection in the future. While defensive stocks may not hold the exciting upside of cyclicals in boom times, they may offer some comforting resilience in times of uncertainty.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson ofStockopedia.com, the rules-based stockmarket investing website. You canclick here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

●     Interactive Investor readers can enjoy a completely FREE 5-day trial of Stockopedia by clicking here.

It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"