After the share market shocks of the past few days, the instinct among some investors will be to call for the tin hat and seek safety in classic defensive stocks. But this is a case when instinct could be plain wrong.
First, it may be that the worst is already over. After such an unusually smooth and exponential climb on Wall Street over the past year, it doesn’t automatically follow that this is a turning point. There are still plenty who argue that the so-called melt-up will resume shortly. Doing nothing is often the best policy in these circumstances.
Second, even if this is the beginning of a more prolonged and painful bear market, it doesn’t mean it will play by the normal rules. The defensive stocks that have provided a safe haven in the past won’t necessarily work this time around.
While bear markets usually presage a recession, there is no evidence of a serious slowdown looming this time. If anything, the world’s biggest economic powerhouses — the United States, the eurozone and China — are all picking up speed. So are company profits.
The trigger for this share market judder has been the unusually strong jobs and wages performance in the US. This has raised the spectre of a jump in inflation, which in turn has triggered fears of a faster round of rate rises by the US Federal Reserve. Hence the spike in bond yields. That, in turn, points to higher borrowing costs for companies.
Analysts at AJ Bell have put the start of the last two big bear markets under the microscope. In 2000, as the technology bubble finally began to deflate, the best-performing sectors included personal products, tobacco, food retailers, drinks companies and general insurance. In 2008, as the banking crisis ripped through the global economy, there was a similar flight to reliable dividend payers, with pharmaceuticals the only sector that produced positive returns.
Russ Mould, investment director at AJ Bell, warns that picking defensive stocks is not that easy this time. Food retailers are under the cosh from the discounters, drug companies are still failing to come up with new blockbuster treatments, while household products makers such as Reckitt Benckiser and Unilever just look plain expensive. Investors may need to look elsewhere for bomb-resistant stock selections.
Here’s a trio that could provide portfolio ballast in difficult markets. The choice of a bank for a safe haven might look odd, but Lloyds Banking Group (67p) has the virtue of being cheap, well capitalised and narrowly focused, while enjoying enormous market power in its home market. Banks tend to do well in rising interest rate environments. Real estate investment trusts trade at meaty discounts to net assets at the moment. Land Securities (937½p) is big, diverse and not too heavily borrowed. And if we are in for more inflationary times, gold, as always, will have its adherents. The FTSE 100 has only two serious gold producers. Randgold Resources looks too exposed to political risk in the Democratic Republic of the Congo. That leaves Fresnillo (£12.85) which has high-grade assets and is also the world’s biggest producer of silver.
ADVICE Buy this trio
WHY Even if this is the beginning of a bear market, investors may find that traditional defensive stocks will not work this time
St Modwen Properties
When Mark Allan joined St Modwen just over a year ago as chief executive, he found a property company with a portfolio that can only be described as erratic and sprawling. His subsequent fine-tuning and focus on fewer, bigger assets that generate rental income, however, is why St Modwen is a strong bet.
The company specialises in buying land that no one else wants to develop. In Swansea, for example, the FTSE 250 company is building new homes and university accommodation on a former oil refinery that BP paid St Modwen to take off its hands. This is where St Modwen’s strength lies.
It also focuses on large brownfield sites that are perfect for manufacturers and for warehouses that can cater for ecommerce.
The problem was its sprawling portfolio. This included a 15-year-long residential land bank but no decent housebuilding business, small retail assets not generating much income and a growing debt pile.
Mr Allan has said the company will focus on expanding its logistics and industrial assets, develop its housebuilding division and capitalise on its reputation for regeneration projects. The rest can be sold.
That means getting rid of assets that are not bringing in money. In the past 12 months the company has sold £260 million worth of land, about 75 per cent of which was in London and the southeast. It reduced its land assets from 55 per cent to 45 per cent of its portfolio. Total debt has dropped from £517 million to £388 million.
The company has also lined up £40 million of retail assets to sell this year as it gets out of retail except on large regeneration sites. Its developing housebuilding business sold 694 homes in 2017, a 43 per cent increase on the previous year.
That has led to a change in its dividend policy. In the past, a lot of cash generated by St Modwen was development profits, as the company sold everything it developed. Now it will hold on to assets that generate an income and link the dividend to the recurring cashflow from this activity and housebuilding profits. This means, as income increases, dividends should grow more strongly.
ADVICE Buy
WHY Dividends will improve as the company focuses on income generating assets
