Playing Defense in a Risky Market

Jul 3, 2024

Amid looming risks in the stock market, traditional defensive sectors may prove less reliable than expected. Here’s how to invest in a shifting environment.

Lisa Shalett

Key Takeaways

  • The S&P 500 Index has had a strong start to 2024, suggesting potential further gains ahead, particularly in a U.S. presidential election year.
  • However, bullish investors may be overlooking key risks, including high equity valuations and a potential downshift in big-tech earnings.
  • Traditional “safe haven” assets and defensive sectors might not be as reliable in today’s unpredictable markets.
  • Investors should consider actively picking individual stocks, with a focus on companies that can achieve expected earnings and potential for growth at a reasonable price.

The S&P 500 Index marks the end of 2024’s first half with another string of new all-time highs. At the end of June, the benchmark stock index was up about 15% through the first half of 2024, its 12th best start to a year since 1950. That may bode well for investors: History suggests that great first halves for the stock market often beget more gains, especially in U.S. presidential election years.


Heading into the second half of the year, however, Morgan Stanley’s Global Investment Committee believes bullish investors who chase the market’s momentum may be overlooking some key risks.


  • The index is top heavy, with the largest 10 companies accounting for about 35% of its market capitalization.
  • Stocks’ valuations are high by historical standards, with prices at 21x expected future earnings, compared to a long-run average forward price-to-earnings (P/E) ratio of around 16.
  • The premium for investing in the index over less-risky government bonds is low, at just 39 basis points.
  • Dividends are low relative to share prices, at about 1.3%
  • Investor complacency is high, with volatility at just 7.7% versus the 25-year average of more than 16%.


These brittle conditions coincide with a potential market inflection on the horizon: Although the outsized, market-leading “Magnificent 7” stocks are expected to post significant profit gains for the second quarter of 2024, Morgan Stanley strategists believe their earnings growth could slow substantially over the following six quarters—a risk to investors with significant exposure to these stocks.

‘Safe-Haven’ Assets Not So Safe?

Against this shifting backdrop, we believe it may be prudent for investors to consider playing some defense in their portfolio, with investments that tend to be less sensitive to volatility. The challenge, however, may be determining what assets in today’s evolving markets are, in fact, “defensive,” as the typical playbook might not work as expected.


For example, traditional “safe haven” assets may not prove so safe. 


  • U.S. Treasuries, for one, have continued to struggle. Federal Reserve interest-rate cuts may be coming, and that should mean higher U.S. government bond prices. However, we see those gains occurring primarily among shorter-term Treasuries, as rising federal debts and deficits will likely continue to put pressure on longer-term government bonds.
  • The U.S. dollar could be a defensive option, but its strength relative to other currencies is already looking extreme, with the Japanese yen at the lowest levels versus the dollar since 1986 and the euro potentially vulnerable to disruptions from France’s political crisis. That may limit the potential for additional gains from investments in the dollar.


In addition, business sectors that are typically considered defensive may not live up to that reputation.


  • Consumer staples companies, which produce items such as food, household goods and hygiene products that are considered essential for everyday use, face the prospect of deflation that could weigh on profit margins. In addition, growing adoption of GLP-1 weight-loss drugs could lead to a structural decline in demand for food, beverage and other consumer goods.
  • Real estate and utilities companies have traditionally been defensive plays, but current earnings forecasts for these sectors assume that they are poised to improve margins sizably—which is by no means guaranteed. What’s more, they are no longer monolithic sectors that are easy to own passively; investors may need to differentiate the outlooks for individual companies.

How to Invest Today

Considering these dynamics, perhaps the best “defensive” option is one of active stock-picking anchored on companies’ ability to deliver on realistic earnings targets.


Investors should consider key pockets where growth may be found at a reasonable price, such as health care, industrials, aerospace and defense, select power generation and grid infrastructure, financials and residential real estate investment trusts (REITs).


Also consider investment opportunities in Japan, gold, hedge funds and investment-grade credit.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from July 1, 2024, “Redefining ‘Defense’.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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