3 Defensive Stock Alternatives to Bonds If Interest Rates Drop

Key Points

• A lowered interest rate from the Fed may cause bond prices to rise, pushing some defensive others to search for alternative plays.
• Consumer staples and utilities names like Colgate-Palmolive and PG&E may appeal to conservative investment strategies when bonds become expensive.
• Among the best of these defensive stocks are those with a stable brand, a strong dividend history, and expected top- or bottom-line growth.

Bonds play a central role in the investment strategies of many defensive or conservative investors. The price of bonds shifts in an inverse fashion compared to yields, meaning that as the Federal Reserve sets a higher interest rate, bond prices tend to fall. Similarly, when the Fed reduces rates—as investors have anticipated for months—lower yields mean that bond prices tend to rise.

This can be a boon for bond investors as it makes fixed-rate bonds issued prior to the Fed's decision to lower rates suddenly more attractive. But for some investors, higher bond prices make the space more difficult or less beneficial to access. In those cases, turning to stocks that represent a strong defensive play can be a suitable, if also somewhat riskier, alternative to bonds.

CL: Top- and Bottom-Line Growth and Impressive Dividend History

Colgate-Palmolive Co. NYSE: CL is a titan of the consumer staples sector, responsible for brands including Irish Spring, Tom's of Maine, Speed Stick, and many more. The firm is incredibly well-established but also has managed to generate both top- and bottom-line growth in the latest quarter, when net sales rose by 4.9% and diluted EPS surged by 48%. Profit margin has also grown by 280 basis points in the most recent quarter, a sign of successful efficiency measures.

The company remains optimistic about its prospects for growth this year, with expected full-year net sales growth of between 2% and 5%, double-digit EPS growth, and a forecast for continued gross profit margin expansion.

For defensive investors, the combination of brand and operational stability and the potential for further growth is a powerful one. Add to this the fact that Colgate has a 62-year history of increasing its dividend and annualized 3-year dividend growth of almost 3%, and investors have yet another reason to consider loading up on the maker of household goods.

PCG: Major Presence, Stock Momentum

With a market capitalization of close to $57 billion and a firm position in the large California market, PG&E Corp. NYSE: PCG is one of the major players in the utilities space. It posted an earnings beat in its latest quarterly report and is forecast to see nearly 9% earnings growth in its upcoming report as well, so the firm continues to find ways to grow its operations. This may be one of the key reasons why PG&E shares are up 16% in the last year.

As a defensive play, utilities stocks are difficult to beat: they are an essential for consumers across the country and are not likely to be removed from a home budget during periods of economic volatility. At the same time, however, PG&E has faced backlash in recent months for increasing its prices in response to damage from weather events. The California Public Utilities Commission approved the most recent rate hike in September and represents the fourth such increase this year.

Further, the utilities industry is subject to strict regulations, and the regulatory landscape could shift significantly depending on the outcome of the November election, which may bring about unexpected changes to PG&E's operations.

SYY: Value Relative to Peers and Growth Potential

Sysco Corp. NYSE: SYY, distributor of a host of frozen, packaged, and fresh foods, is well-positioned in the consumer staples sector as its forward P/E ratio of 16.7 is somewhat lower than many of its rivals. It also offers a return on equity of over 102%, meaning that is generating returns efficiently relative to the equity investments of shareholders.

Sysco stock is up 10% in the last year, but analysts see at least another 10% in upside potential based on an average price target of $85.27.

This may be due to its earnings beat in the latest quarter and projected earnings growth of 8%, all of which could help to boost cash flows and allow the company to continue its 56-year trend of increasing dividends.

Defensive Plays To Weather Interest Rate Fluctuations

As interest rates shift, watch for traditional defensive sectors like consumer staples and utilities to respond. While not every company within these sectors will get a boost, and past performance is not a guarantee of future trends, there is a reason why investors continually come back to these relatively safe corners of the market when volatility increases.