Ukraine’s invasion and the Power of defensive stocks
The ongoing invasion of Ukraine by Russia has opened a Pandora’s Box of deepened crisis along the global economic fault lines. Russia, the second superpower, is daily contending with new sanctions across the globe. This may reverse the country’s globalization to the level prior to the breakup of the Soviet Union. That period, its centralized planning was more of autarky or self -sufficiency rather than global trade or financial flows. However, the collapse of the Soviet Union launched Russia into the global economy and the country’s economic reformers took advantage of this to speed up rapid economic growth and development.
Every country is beginning to feel the negative impacts of the current war between Russia and Ukraine and this may snowball into the third world war if not curtailed. Prior to the invasion of Ukraine, Nigerian economy has been in dire need of structural reform due to myriad of issues, including macroeconomic vagaries, low output, weak purchasing power of consumers, high inflation, currency devaluation and forex scarcity among others. This is not to discount the general effects of insecurity across all economic activities.
Nigeria, like other countries is beginning to face the downside risks of the war through issues such as escalation of energy prices, especially petroleum, diesel, aviation fuel and gas. The Debt Management Office (DMO) says Nigeria’s total public debt stock climbed to N39.556 trillion in 2021 against N32.915 trillion in 2020. This is another elephant in the room against 2022 budget implementation.
The ratio of the country’s debt to revenue is above 70 percent, whereas, the government is flaunting that of debt to Gross Domestic Product (GDP) as window-dressing to create an impression that the country’s borrowing spree is still within the international threshold. Food inflation is on a steady increase as cost of food stuff, including flour and bread are rising exponentially by the day. Experts have consistently noted that the present state of Nigeria’s economy would continue to fuel inflationary pressures.
The full-scale invasion of Ukraine by Russia has brought the global financial markets into turmoil. Western countries’ continued global sanctions against Russia have started to have backlash effects on the banks and other companies of these countries. At the last count, no fewer than 20 major companies have exited Russia. Stock market is information-driven. Operations of the companies that have pulled out of Russia may be affected and such can reduce their income and ability to deliver superior return on investment in the short and medium term. This is fast causing disquiet in the global financial market as investors are nervous on where to put their money under this heightened state of uncertainty. In a volatile investment environment, investors search for safety. They need shelter from the storm.
Investment in defensive stocks is the way to go. Defensive stocks are for all seasons. The stocks have dominant position in a huge market. Their competitive advantage is sustainable. They are not like growth stocks that have direct relationship with the economy and therefore susceptible to unpredictable price changes during economic boom and burst.
Defensive stocks are those of companies whose products and services are on constant demand irrespective of the changes in the overall economy. Their companies are associated with high cash flow and the stocks align with all phases of the business cycle. For instance, stocks of the companies in utilities, healthcare, consumer stables and Real Estate Investment Trusts (REITs), telecoms and discount retailers sectors are good examples of defensive stocks.
They are also called non -cyclical stocks because unlike growth or cyclical stocks, they are not highly correlated with any business cycle. Apart from stable earnings, they pay regular dividends regardless of the overall state of the market. Defensive stocks protect a portfolio of asset classes from a loss. But the stocks may not offer much growth potential. They generate substantial long term gains with lower risks during recession. Every investment manager goes for defensive stocks at a period of uncertainties.
It takes a terrible catastrophe to derail the operations of such companies. The grandmaster of investment in stocks, Warren Buffett focuses more on defensive stocks as part of his investment strategy. The stocks as a group have a higher Sharpe Ratio higher than the stock market as a whole. This presents a strong argument that stocks are better than others. The Sharpe Ratio, developed by William Sharpe helps investors to know their rate of returns in relation to the risks.
Defensive stocks are not without feet of clay. During bull market, the low volatility of defensive stocks lead to lower gains. Investors who do not contact their stockbrokers for investment advice may panic and dump their defensive stocks. They often later realize that it is a tactical error. The stocks can underperform during periods of economic growth. While other stocks are soaring during economic growth, defensive stocks may remain constant. Defensive stocks stand the risk of being over-valued during economic decline because many investors would go for the stocks on the basis that they are safety nets.
Oni, an integrated communications strategist, wrote from Lagos.