By Jacob Sonenshine

The market's rally brings it to a level that makes it vulnerable to declines. Buying cheap "defensive" stocks is a smart way to protect your portfolio.

Last week, in the Trader Column, we pointed out that defensives, broadly, were a good place to start looking for stocks. This week, we're zeroing in on specific names.

The S&P 500 was holding steady at a smidgen more than 6000 on Monday and needs a just over 2% gain to reclaim its Feb. 19 record closing high of 6,144.

At about 22 times analysts' aggregate expected earnings for the coming 12 months -- close to the highest since 2022 -- the index is expensive.

That's why buying the S&P 500 at this price would be scary. If earnings disappoint even a little, the index has nowhere to go but lower. A drop in earnings estimates would invite sellers to come in and knock stocks down.

And there are signs that earnings could be dragged down by what's happening in the broader economy. President Donald Trump's tax-and-spending bill, headed to the Senate after passing the House, would add $2.4 trillion to the federal deficit, forcing the Treasury Department to borrow heavily. The borrowing would drive up bond yields, which could slow economic growth -- and, consequently, earnings.

Plus, the administration's tariffs policy could push inflation higher, pushing yields higher, pressuring the economic outlook, and denting stocks.

Still, most investors don't want to sit on the sidelines in case any pullback is shallow, and the index does power higher. A proven way to invest in stocks, and still have cover, is to buy defensive stocks. They're defensive because the sectors they're mostly in -- utilities, consumer staples, REITs, and healthcare, for example -- don't see much, if any, hit to demand and profits if the economy falters.

Lately, defensives have underperformed global "cyclicals," which are more sensitive to economic fluctuations. Cyclicals have done so well that they're trading as high relative to defensives as they have in the past 15 years, according to UBS equity strategist Andrew Garthwaite.

The degree to which cyclical stocks are higher relative to defensives historically correlates to times when the global composite purchasing manager's new orders index, which shows extent to which companies are preparing for higher demand, is at the high end of its historical range. But right now, it's closer to the lower end, suggesting that defensive stocks are likely to start to outperform for a period going forward.

That's why Trivariate Research's Adam Parker screened for the best defensive stocks to consider -- companies that have a smaller range of analysts' earnings estimates, which indicates they have stable, predictable businesses. To make Parkers screen, a company had to have consensus estimates calling for profit growth and had to trade at earnings multiples below their long-term averages.

The list includes Salesforce, Motorola Solutions, Question Diagnostics, Merit Medical Systems, and utility provider The Southern Company.

An especially interesting name is Exelon, the $43 billion utility provider for a handful of East Coast states and Illinois. The stock has underperformed the S&P 500, along with other U.S. utilities, since early April. Exelon trades at 14 times earnings, versus a five-year average of 16 times.

The utilities business has essentially no sensitivity to economic cycles. Exelon's earnings have grown in each of the past three years. The company's $60 billion-plus asset base has grown, and is expected to keep growing. As states have allowed the company to charge customers enough to earn a steady rate of return on those assets, earnings should grow just over 6% annually over the coming three years, according to FactSet.

If growth meets expectations, the stock should move higher over time. It could gain even faster than the rate of earnings growth if defensives, at large, move more into favor and the multiple inches higher.

So put Exelon on your shopping list. And a take a look at the others, too. It's time to play it safe. Go, defensive.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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June 09, 2025 12:46 ET (16:46 GMT)

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