Where to Go If Large Tech Is Wilting? Big Defensive Stocks

Higher interest rates and tech stocks don’t mix, as we saw with Tuesday’s market reaction to talk of imminent tightening from the Federal Reserve. The momentum tech-tilted Nasdaq 100 suffered a 1.1% fall yesterday, a quarter percentage point worse than the overall S&P 500’s dip.

So, if that’s where things are headed, where can stock investors go for decent returns? For Morgan Stanley’s chief US equity strategist, Mike Wilson, the answer is what he calls “large-cap quality defensive stocks.” That’s as opposed to large-cap quality growth stocks, mostly tech names—i.e., the ones that just got pounded. Prime example: Microsoft fell 3.3% Tuesday.

Quality is a Wall Street watchword lately, meaning solid businesses, strong balance sheets, and growing earnings and revenue. Those traits often are embodied in large-caps—those with market values of $10 billion and up—regardless of the sector they inhabit.

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Appearing on CNBC, Wilson lauded the defensive end of the large-cap quality spectrum as “bastions” and “safety nets.”

Overall, Wilson and his firm are bullish, with a year-end projection for the S&P 500 of 4,800; it closed yesterday at 4,634. That implies a 3.5% increase through the end of this month. He is more sanguine than he was in September, when he wondered whether trouble ahead would come from “fire” (inflation) or “ice” (a market correction). “Fire is happening now with inflation running hot,” he told the TV viewers.

But Wilson added that he expected an end to supply-chain disruptions and higher rates from the Federal Reserve to douse that problem. Meanwhile, regardless of whether a correction appears, he expressed wariness about risk-on strategies involving the tech leaders that have until recently been powering the market. The Nasdaq 100 is off 4% from a month ago.

“They’re falling by the wayside,” he remarked. Even worse off are small-caps, which now are in correction territory. Over the past month, the category’s benchmark, the Russell 2000, is down more than 10%.

And that’s where large-cap quality defensive plays come in. They are not necessarily cheap, sporting price-earnings (P/E) ratios well north of the market’s historical average of around 16. The point is, in Wilson’s estimation, that they can withstand headwinds better than can the tech behemoths, whose future returns would ebb as interest rates ascend.

While Wilson didn’t single out any particular stocks, let’s take a trio of large defensive stalwarts that meet his criteria. Their returns over the past month have hardly been stratospheric, yet they are a marked contrast to the tech titan’s downdraft. Becton Dickinson, the medical equipment supplier, has risen 1.2% over the past month. Clorox, the cleanser product company that briefly was all the rage at the pandemic’s outset, is ahead 1.8%. And soft-drink maker Coca-Cola has blipped up 2.2%.

Although noting that the S&P 500 in toto was “fairly resilient,” Wilson termed the large-cap tech outfits the losers in the current “mid-cycle transition.” A marker for the trend, he said, is the shrinking of valuations. Since the end of 2020, when stocks enjoyed a huge turnaround from the early-pandemic lows, the S&P 500’s P/E has slid to 25 from almost 40. In historical terms, the current level is still high, just nothing like before.

Up ahead, there could be an earnings slowdown and margin compression, he warned. Not for his bastions, though.

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Tags: Becton Dickinson, Clorox, correction, large-cap quality defensive stocks, large-cap quality growth stocks, large-caps, Microsoft, Mike Wilson, Morgan Stanley, Nasdaq 100, P/E, quality, S&P 500, small caps, The Coca-Cola Company

Once upon a time, Warren Buffett said he wouldn’t buy tech stocks because he didn’t understand them. That was then. Today, the equity portfolio of his Berkshire Hathaway holding company is overwhelmed with tech. Specifically, Apple.

The iPhone maker now makes up almost half of Berkshire’s stock holdings, some 48.4%, according to Bespoke Investment Group. The firm took the Buffett company’s latest filing, as of Sept. 30, and figured out its holdings’ value right now using current stock prices.

Back in March, Apple had just a little more than a third of the Berkshire stock portfolio, and its swelling presence there owes to appreciation, not added shares. Most of Buffett’s Apple stake was acquired between 2016 and 2018. He does adjust his portfolio, although major moves are uncommon. (Exception: He ditched his airline stocks last year as pandemic fears grounded most flights.)

A lot of Apple’s share-price surge has come since the end of the third quarter, with Bespoke calculating that it rose 28.5% during the past two-plus months. Other top Berkshire positions haven’t appreciated nearly as well in the current quarter, and so they make up a smaller portion of the Berkshire equity portfolio. By Bespoke’s measure, its second largest holding, Bank of America, has just 13.3%. The other leading positions are even smaller: American Express (7.5%), Coca-Cola (6.9%), and Kraft Heinz (3.3%).

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The Oracle of Omaha’s conversion to tech, in particular to Apple, owes much to realizing that Steve Jobs’ brainchild is a wealth-creation machine. “It’s probably the best business I know in the world,” Buffett told CNBC in February. “I don’t think of Apple as a stock. I think of it as our third business.” Berkshire also owns operating companies, particularly in insurance, as well as stocks in Amazon and cloud data platform Snowflake, among other techy names.

At a price/earnings (P/E) ratio of 35, the iPhone company is hardly a value play—and value stocks are what Buffett built his fortune upon. But after the March 2020 market dive, he didn’t move much into value shares and was content to let his earlier positions ride. He has an enormous cash stash, some $150 billion, and has been reluctant to put it to work. “Even though Buffett’s strategy of ‘be greedy only when others are fearful’ has historically been a successful one, he did not aggressively buy the COVID-related dip, and the company now has record amounts of cash stockpiled on its balance sheet,” Bespoke observed.

Thus far in the fourth quarter, Apple has traded a lot higher than Berkshire’s own shares, Bespoke finds. In the year’s final period, Buffett’s B shares are up 6.5% and Apple’s stock is ahead 28.5%. For the year as a whole, Berkshire has risen 25%, slightly more than the S&P 500 (24.3%). Apple, though, has climbed 33%.

After all, with a $2.8 trillion market cap, Apple is the world’s most valuable stock, a distinction it has been trading with Microsoft. Berkshire used to own Microsoft, but Buffett shed it because of his friendship with Bill Gates, the software firm’s co-founder. Buffett has said he feared the possible appearance that he would benefit from inside information.

Given Apple’s prominence in Buffett’s holdings, one might almost say that Berkshire is a … tech stock.