Four defensive stocks to buy now

published 25 September 2009

The bank crises and their aftershocks seemed pretty alarming at the time. But for most investors those days are long gone. We aren't seeing an apocalyptic end to capitalism, just a bad recession. The wrinkle is that this is a recession associated with a banking crisis. Banking-crisis recessions tend to be followed by anaemic recoveries thanks to the damage done to the mechanism for recycling savings and allocating capital. Given that pre-crash consumption was driven by credit credit that is no longer available a return to those levels of economic activity is unlikely. Add in weak demand, unemployment and spare capacity, and I see interest rates remaining lower for longer than many people expect.

Economic news has been more encouraging recently. But these days it pays to remember that the words 'off a low base' should generally be added after the word 'increase'. Note, for example, that July's 9.6% rise in US new home sales came in the context of a 76.3% peak-to-trough fall in volumes. We expect that a fairly weak global recovery will keep financial markets volatile. To manage this we use an advanced overlay strategy (which also increases diversification and allows us to access specialist return opportunities).

Right now I would look to maintain some defensiveness in any portfolio. Given our 'lower for longer' interest-rate expectation, top-grade corporate bonds should remain in portfolios at present. Equities that can produce a high and sustainable income also look sensible.

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One cash-generative company we like is Vodafone (LSE: VOD), which trades on a price/earnings ratio of around ten times 2010 forecast earnings and yields near 6%. On top of its activities in mature markets, the company has significant exposure to long-term growth in emerging markets. If its holding in US group Verizon is eventually sold, this could generate a significant windfall.

Oil prices have moved even further off their lows than share prices, but major oil companies' share prices have failed to match this trend. On a p/e of just below ten times forecast 2010 earnings and yielding above 6%, BP (LSE: BP) will need a very sharp and sustained fall in the price of oil to look unattractive. So we continue to like it. The company has also just made a promising large deep-water discovery in the Gulf of Mexico.

I also like Serco (LSE: SRP), though this is a growth rather than a yield stock. Given the shocking state of UK and US government finances, there will clearly be pressure on government spending for some time to come. However, the trend to outsource seems pretty entrenched and governments need all the help they can get in cutting costs and improving efficiency. Serco, with contracts for everything from managing hospitals to providing training support for the military, should continue to do well.

Finally, food retailers look very cheap p/es and yields are very similar to the broader UK market, rather than at the premiums usually associated with such defensive business profiles. So Tesco (LSE: TSCO) shares look like the latest special offer to take up, in case we see a slightly weaker equity market trend.

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