What to Do During Market Fluctuations at High Levels? Defensive Asset Allocation Guide and Selected Defensive Stocks in U.S. Equities

Why Is Now the Time to Focus on Defensive Assets?

In 2024, the US stock market has been driven by AI-related topics, with most stocks accumulating significant gains. Price-to-earnings ratios are at relatively high levels, and investor sentiment remains high. Financial institutions generally expect a short-term peak to be imminent, coupled with factors such as potential rate cuts in the US and upcoming election variables, leading to increasing market volatility risks. Against this backdrop, many investors are beginning to consider how to participate in growth while hedging against substantial pullbacks.

Defensive assets are precisely the important tools to address such situations. Simply put, when the market faces a decline, these assets either exhibit smaller volatility or move inversely to stocks, effectively buffering the risk of an investment portfolio.

What Types of Defensive Assets Are There?

Defensive assets can be broadly divided into three categories, allowing investors to choose based on their risk tolerance:

Market Inverse Assets — Instruments like gold, US dollar cash, and US Treasury bonds tend to move opposite to stock trends, mainly used to hedge stock market risk. When stocks undergo significant adjustments, these assets often maintain or increase in value.

Assets Independent of the Stock Market — Certain assets perform independently of stock market fluctuations, such as cryptocurrencies, serving as diversification within a portfolio.

Stable-Growth Defensive Stocks — A special category of companies in the stock market whose profits are largely unaffected by economic cycles, operating steadily at their own pace. Utilities, consumer staples, healthcare, and telecommunications are typical examples. These stocks tend to have relatively small fluctuations, making them less prone to sharp drops or short-term surges.

Core Characteristics of Defensive Stocks

Defensive stocks are also called non-cyclical stocks, which can provide stable returns even during economic recessions. For example, even in a downturn, people still need to buy food, beverages, daily necessities, and continue to use healthcare and telecom services. As a result, companies in these industries often become representatives of defensive stocks, offering a certain level of protection for investors.

These stocks typically pay regular, stable dividends, but their growth potential during bull markets may be less than high-growth stocks. From an opportunity cost perspective, holding defensive stocks as core holdings over the long term may not be cost-effective, as their profits often lag behind the broader market. However, during periods of intense market volatility or clear signals of economic instability, the stable returns of these stocks become quite attractive.

When Is the Best Time to Increase Holdings of Defensive Stocks?

During confirmed economic recessions or rate hike cycles — Take 2022 as an example, when CPI in Europe and the US surged, and the Federal Reserve and European Central Bank decided to significantly raise interest rates to curb inflation. Although the exact magnitude of hikes is hard to predict, the direction of substantial rate increases is clear, making it an ideal time to buy defensive stocks. Stable profit companies like Chunghwa Telecom in Taiwan and Apple in the US are ideal choices. Legendary investor Warren Buffett has long positioned in defensive assets like Apple, ExxonMobil, and Chevron, based on this logic.

Before rate cuts — Historically, the Fed tends to cut rates only after economic downturns and rising unemployment. The appearance of rate cuts often signals economic concerns, making it a good opportunity to invest in defensive stocks. At this time, the ROE (Return on Equity) of such companies is usually much higher than the current US short-term government bond yield (around 5%), making them relatively more attractive.

The Top Three US Defensive Stocks to Watch Now

As the world approaches a rate-cutting cycle and geopolitical risks continue to escalate, the most worthwhile defensive assets should have the potential to benefit continuously when these events occur. The following three stocks are relatively aligned with this condition:

Johnson & Johnson (JNJ.US) — Steady growth from a healthcare giant

Johnson & Johnson’s stock price fluctuated during the pandemic, but its profitability did not decline. Since 2021, although the stock has oscillated at high levels, the company’s earnings have continued to grow. After a brief profit adjustment following reopening in 2022, J&J returned to growth in 2023 through the spin-off of its consumer health division Kenvue, streamlining assets and restoring profitability.

By Q1 2024, despite slightly lower-than-expected revenue from medical devices, sales of cancer drug Carvykti met expectations, and overall EPS exceeded forecasts at 2.71 yuan. Driven by positive news, the dividend was also increased from 1.19 to 1.24 yuan per share.

Based on these figures, J&J’s current P/E ratio is under 15, indicating undervaluation. Analysts expect steady profit growth over the next two years, combined with increasing dividends, making it a high-quality option for defensive allocation.

Apple (AAPL.US) — Deep ecosystem moat

Apple’s revenue sources are diverse and reliable. Google pays billions annually to be the default search engine on iPhone, and the App Store’s commission model provides stable cash flow—Apple takes a 30% cut on app sales. Its product lines include smartphones, tablets, headphones, and computers, continuously generating revenue.

Recently, Apple has invested resources into smart cars and AI, aligning with market expectations. Although its stock performance has been sluggish, compared to some overhyped competitors, Apple’s valuation remains attractive.

Market concerns include antitrust fines in Europe, slowing hardware sales, and R&D costs for electric vehicles. However, a closer analysis shows these risks are not major obstacles.

Europe’s €1.8 billion fine on media streaming competitors has limited impact on the stock. Hardware sales may slow, but the rise of AI-powered smartphones will drive replacement cycles, and Apple’s computing advantages and efficient heat dissipation design are clearly superior to competitors like Samsung. Regarding EV investments, even if Apple doesn’t manufacture complete vehicles, its patents and ecosystem can generate revenue—e.g., Xiaomi’s SU7 launch emphasized seamless integration with iPad, demonstrating that Apple can profit from its ecosystem and software components even without building cars.

Buffett’s reduction of Apple holdings was mainly to avoid exceeding the 6% ownership limit for regulatory reasons, not due to pessimism about the business. Apple’s stable profits and reasonable valuation make it worth continued attention, with analysts forecasting annual profit growth potential.

AT&T (T.US) — Infrastructure upgrades benefit

AT&T is streamlining operations by spinning off well-known streaming services like HBO and CNN, focusing on telecom services, which will lead to a more stable profit structure. US government policies increasing infrastructure investment are favorable for the company’s prospects.

Although revenue has decreased post-spinoff, the stock is at a relatively low base with a reasonable P/E ratio. Analysts forecast gradual profit stabilization over the next two years, with government infrastructure policies providing long-term growth momentum.

Summary

Defensive stocks and assets benefit from the lagging effects of economic slowdown and high interest rates. The Fed’s rate cuts will help improve the performance of defensive sectors. Recently, the decline in long-term bond yields may also trigger larger rebounds in defensive sectors. Therefore, the 2024 investment strategy should consider balancing growth stocks with defensive stocks.

Investors can also explore other defensive tools like gold, US dollar cash, and US Treasury bonds to hedge against high volatility. Regardless of capital size, understanding defensive assets and hedging strategies is essential to reduce market volatility risks. In today’s high-level market fluctuations, a moderate allocation to defensive targets allows participation in growth while protecting principal, making it a relatively wise balance.