Signs of a top in the US stock market are emerging. Why have these 3 defensive asset stocks become safe havens?

The U.S. stock market in 2024 has already experienced a wave of notable AI-related hype, with most individual stocks trading at historically high P/E ratios. Amid the dual pressures of the Federal Reserve’s imminent rate cuts and escalating geopolitical risks, market volatility is expanding. In such an environment, understanding how to allocate defensive assets has become an essential skill for investors.

Why is now the time to position in defensive stocks?

First, it’s important to understand a key market logic: defensive stocks are not always the optimal choice at all times. While these companies tend to have stable profits, during economic upswings, their gains often lag behind the broader market. From an opportunity cost perspective, holding defensive stocks long-term is equivalent to missing out on the market’s upside.

However, the situation changes when the following signals appear: first, the economic cycle is about to enter a downturn; second, there is a significant shift in central bank policies. For example, in 2022, European and American central banks sharply raised interest rates to combat inflation, which was a prime window for actively buying defensive stocks.

Today’s scenario is similar. The Federal Reserve is expected to initiate a rate-cut cycle, and historical experience shows that rate cuts often signal the beginning of an economic slowdown. Under this expectation, defensive companies with ROE (Return on Equity) far above 5%—compared to current short-term government bond yields—become much more attractive.

Three classifications of defensive assets

Broadly speaking, defensive assets can be divided into three categories. The first is market inverse assets, including gold, USD cash, U.S. Treasuries, etc., which tend to have a negative correlation with stocks and are mainly used to hedge market risk. The second category is assets independent of the stock market, such as cryptocurrencies, which have no direct correlation.

The third category, and the focus of this article, is stable-yield niche stocks, also known as non-cyclical stocks. These companies’ performance is largely unaffected by economic cycles and grow at their own pace, such as utilities, food and beverages, healthcare, and telecommunications. Even during recessions, consumers still need to buy daily necessities, receive medical services, and use communication networks.

The core characteristic of defensive stocks is relatively mild volatility—they are not prone to large declines, but also not likely to surge significantly. In other words, they offer steady long-term returns and stable dividends rather than short-term capital gains.

Three stock opportunities in defensive assets

Johnson & Johnson (JNJ.US)—Optimizing the structure of a healthcare giant

Johnson & Johnson’s stock price fluctuated during the pandemic, but its profitability remained intact. Since 2021, even as the stock price oscillated in a high range, revenue continued to grow.

After a brief profit dip in 2022, the company achieved asset-lighting by spinning off its consumer health division Kenvue in 2023, which helped profits resume an expansion trajectory. In Q1 2024, despite slightly lower-than-expected medical device revenue, sales of the new cancer drug Carvykti met expectations, bringing overall EPS to 2.71, outperforming market forecasts.

More notably, the company’s dividend policy has also been optimized—quarterly dividends per share increased from $1.19 to $1.24. Based on these figures, Johnson & Johnson’s current P/E ratio is below 15, indicating it is undervalued. Analysts forecast steady profit growth over the next two years, and Kenvue’s stock price has bottomed out and begun to rebound.

Apple (AAPL.US)—Hidden defense within the ecosystem

Apple’s revenue structure is diverse and stable. Google pays Apple billions annually to maintain default search on iPhones, and App Store commissions are a continuous source of income—every in-app sale pays 30% to Apple.

Product lines such as smartphones, tablets, headphones, and computers generate ongoing revenue. Recently, Apple has increased investments in smart cars and AI, aligning with market expectations.

Compared to tech stocks hyped up by AI themes, Apple’s stock has been relatively subdued over the past two years, making its valuation more attractive. This is mainly due to three concerns: antitrust fines, slowing hardware sales growth, and risks related to electric vehicle investments. However, these worries are less severe than they seem.

Antitrust fines (e.g., Europe’s €1.8 billion penalty for anti-competition in streaming music) have become a reality but have limited marginal impact on the stock price. While hardware sales growth has slowed, the AI smartphone wave is expected to trigger a replacement cycle, and Apple’s advantages in computing performance and thermal management are clear compared to Samsung and peers. Although Apple has not developed its own autonomous vehicle, its patents and ecosystem still generate revenue—Xiaomi’s SU7 launch emphasizes seamless integration with iPads, illustrating that even without its own car, Apple is embedded in the entire ecosystem.

As for Buffett’s reduced holdings in Apple, the main reason is to avoid crossing the 6% ownership threshold mandated by regulations, not a negative outlook on the company’s prospects. Apple’s current stable profits, reasonable P/E ratio, and growth potential make it a key focus during market highs. Analysts expect continued annual profit growth.

AT&T (T.US)—Beneficiary of infrastructure investments

U.S. telecom giant AT&T is undergoing a major business spin-off, separating assets like HBO, CNN, and other streaming media. This allows AT&T to focus more on core telecom services, resulting in a more stable profit structure.

Policy support also favors AT&T’s outlook. The U.S. government is increasing investments in infrastructure such as telecommunications, providing policy backing. Although revenue has declined post-spin-off, considering the lower base of the stock price, the P/E ratio remains reasonable. Analysts forecast that AT&T’s profits will gradually stabilize at a higher level over the next two years.

The balanced approach to defensive strategies

In the current environment of relatively high market levels, expanding allocations to defensive assets amid rising volatility and uncertain economic prospects is a necessary way to reduce portfolio risk. Besides defensive stocks, investors can also consider gold, USD, Treasuries, and other defensive assets to create a multi-layered hedging mechanism.

Regardless of capital size, understanding and practicing hedging strategies is a must for mature investors. Balancing growth and defense, and dynamically adjusting holdings, are key to reducing volatility risk while avoiding missing out on upward opportunities during market cycles.