Stocks that offer shelter in a storm

As any experienced investor knows, there's no single investment type that performs best across all market environments. There will be times when tech, energy, growth, and value stocks each takes the lead, and times when each of these sectors and styles lags.

While it's never possible to perfectly predict what will shine when, there are often patterns that can give investors clues. In the current environment—with corporate earnings strength eroding, and worries growing over the market and economy—investors might want to take a closer look at stocks in defensive sectors.

These are parts of the economy that often show resiliency during a downturn because consumers continue to spend money on these products and services even when times are tight. Take the health care sector, says Eddie Yoon, portfolio manager of the Fidelity^® Select Health Care Portfolio (). "People take their prescriptions whether we're in a recession or not. They go to the hospital whether we're in a recession or not. So demand is less volatile."

In addition to health care, the utilities and consumer staples sectors are also considered to be defensive sectors. As investors might expect, each sector has performed better than the broad market through the volatility we've seen over the past year.

To be sure, past performance is no guarantee of future results. But if you're looking to batten down the hatches on your portfolio, read on for a closer look into each of these 3 sectors, and where Fidelity's portfolio managers have found opportunities.

Utilities: Room to run, with the wind at their back

While utilities are often considered to be a sleepy part of the market, there's been nothing sluggish about their performance this year. Douglas Simmons, manager of the Fidelity^® Select Utilities Portfolio () says that he sees plenty more potential fuel behind the rally.

For one thing, the sector faces much less earnings risk than other parts of the market, he says. Consumers and businesses are likely to continue to spend on utilities even if there's an economic downturn. The companies tend to hold up well in response to inflationary pressures, because they pass higher costs straight through to customers. And as domestic businesses, they don't face the headwinds of a strong dollar that many other sectors currently face.

With earnings growth for the broad market declining, growth expectations for utilities may look increasingly attractive. "Earnings growth expectations for the sector are currently around 7% to 8%, which is kind of what investors are hoping for with the market," says Simmons. "But with utilities, there's a lot less risk."

Yet there's also a compelling longer-term case to be made for the sector, he says.

"The world is moving from a petro-state to an electro-state," Simmons says, such as with increasing adoption of electric vehicles. "There's this energy transition from fossil fuels toward electricity, and that is providing a huge tailwind for the sector in terms of electricity demand and earnings growth." In the short-to-medium term, the Inflation Reduction Act should also provide a direct benefit to the sector, thanks to tax credits and provisions intended to hasten the energy transition.

Simmons says that one portfolio holding that has illustrated these investment themes is NextEra Energy Inc. (), a major US electricity utility that has been working toward decarbonization of its operations.

Finally, while the utilities sector's rally this year may make some investors concerned about valuations, Simmons says that much of those gains were simply catch-up for the sector, which significantly underperformed the broad market over 2019–2021. Valuations remain reasonable, he says.

Health care: Focus on pricing power and resiliency

Similar to utilities, at least some of the health care sector's outperformance this year can be attributed to valuations, says Yoon. "The sector's valuation, relative to its long-term average, came into the year very attractive," he says.

Within the sector, he says that outperformance has been driven by the most defensive types of companies, including large-cap pharmaceutical companies, large-cap pharmaceutical distributors, and large-cap managed care companies.

Given the current inflationary environment, Yoon says he's been focused on identifying companies with "clear and present pricing power." For example, he says, managed care companies (i.e., health insurance networks) are generally able to pass inflationary pressures on to customers—meaning the employers they contract with—through higher premiums. An example of a portfolio holding that has illustrated this thesis is UnitedHealth Group (), one of the largest health insurers in the US.

Another part of the industry that Yoon believes may have good pricing power is the so-called life sciences segment—which includes companies that make specific tools or ingredients used in manufacturing biotech and other drugs—due to the highly specialized nature of their products. Yoon says that portfolio holding Danaher () has exemplified this thesis. The conglomerate has a number of life sciences subsidiaries, including companies that develop and sell tech for developing cell lines, and companies that develop and sell nucleic acid.

Consumer staples: Strength among beverage companies

It makes intuitive sense that companies in the consumer staples sector—which can encompass everything from bread to bacon, and toilet paper to toothpaste—generally hold up well in a rocky economy. We all still need to brush our teeth and eat breakfast in the morning, no matter what the market is doing.

Ben Shuleva, manager of the Fidelity^® Select Consumer Staples Portfolio () says that historically, the sector has outperformed the broad market during recessions. But he also cautions that this time might be different (with the caveat that Fidelity experts do not believe the economy is currently in recession). "Inflation is bad for everyone, and it's bad for consumer staples," he says. The sector underperformed the broad market during the inflationary downturns of the 1970s (though subsequently outperformed), so he is circumspect about pounding the table.

He's been looking for companies that may hold up best, within the sector, under the combined pressures of a softening economy and rising input prices. One key dynamic he's focused on is that when consumers are pinched, they often trade down from brand names to so-called "private label" products (meaning a store's in-house brand, such as 365-branded products at Whole Foods, or Kirkland-branded products at Costco), which often sell at significant discounts to name-brand competitors.

"I'm looking for subsectors that are more consolidated, with high barriers to entry, less competition from private labels, and a better ability to raise prices," he says.

Shuleva says he's found the strongest opportunities among beverage companies, including the main soda companies. "There are basically only 3 players of scale in the subsector, and the barriers to entry are very high," he says. Plus, there's essentially no competition from private labels. If a consumer wants a cola, they usually only have 2 options to choose from—Coke and Pepsi.

Shuleva says that portfolio holding Coca Cola Co. () has exemplified this investment thesis. And while the company may be best-known for its flagship sugary soda, its brands also now include potentially healthier alternatives, such as Dasani and Smartwater. He says that portfolio holding Keurig Dr Pepper Inc. () is another company that has followed this investment thesis but that also has had an added benefit: The company sells relatively little of its products outside the US, which means it has felt less pain from a strong US dollar than its competitors.

To learn more, check out the Fidelity^® Select Utilities Portfolio, Fidelity^® Select Health Care Portfolio, and Fidelity^® Select Consumer Staples Portfolio, or consider evaluating potential investments with our Stock Screener or Exchange-Traded Fund (ETF) Screener. You can also learn more about sector investing and read more recent market insights and commentary from Fidelity's portfolio managers.