Best defensive shares to buy in Q4

Despite recent signals from the Bank of England Monetary Policy Committee that inflation may ease in the spring, the UK economy remains fragile. According to the latest data from the Office of National Statistics, Britain’s economy contracted more in the third-quarter than previously thought, underperforming other major economies due to inflation. UK output was down by 0.3% between the second and third-quarter, according to the ONS – more than previous estimates of 0.2%.

In fact, the UK economy was 0.8% below the level seen in the fourth-quarter of 2019 before the Covid-19 pandemic hit. Previous estimates were of a 0.4% dip, while the US economy grew 4.3% over the same period and the Eurozone by 2.2%.

“Our revised figures show the economy performed slightly less well over the last year than we previously estimated, with manufacturing and electricity generation notably weaker,” said Darren Morgan, director of economic statistics at ONS.

The effect of inflation on UK households is thought to be the main culprit, with disposable income down by 0.5% between the second and third-quarters and household spending down by 1.1% in the third-quarter.

As such, it’s a good idea to include some defensive shares in your portfolio. Here are three stocks we think offer defensive qualities in tough economic times.

GlaxoSmithKline – defensive attractions

The pharmaceutical sector tends to offer defensive attractions as doctors and patients are always in need of the companies’ products, regardless of the machinations of the worldwide economy.

Shares in GlaxoSmithKline recently got a shot in the arm after a US judge threw out 2,500 major lawsuits that claimed its heartburn drug Zantac caused cancer. Analysts at broker Morgan Stanley had been concerned that the issue could have cost the company $45 billion in compensation claims. While there is still the possibility of individual lawsuits against Glaxo, this ruling ends a substantial concern for investors and a major overhang on the shares.

Glaxo had a busy 2022, deflecting a bid for its healthcare arm Haleon from Unilever earlier this year and then spinning it out in July. Meanwhile, its product for myelofibrosis has been submitted to the US Food and Drug Administration. The company also recently raised its earnings guidance for the full-year to an increase in sales of 8% to 10% at constant exchange rates, and growth in adjusted operating profit of 15% to 17%. Its vaccine for shingles Shingrix is enjoying strong growth, with sales up 36% at constant exchange rates.

The shares have underperformed this year compared to AstraZeneca’s and, at 1,427p, are down 11% for the year. However, analysts at JP Morgan Chase think the shares could reach 1,600p.

Diageo – drinks market remains robust

Shares in the drinks giant are down 9% over the year to 3662.5p but offer defensive qualities. Although Diageo is experiencing challenging trading conditions due to input cost hikes, the cost of living crisis in the UK and the war in the Ukraine, the company recently unveiled strong sales. Diageo reported net sales growth of 21.4% to £15.5 billion at the full-year, thanks to solid organic sales growth, with double-digit growth seen across all regions.

The company behind Johnny Walker and Pimm’s, among many other brands, says it is seeing the continued recovery of on-trade sales following the Covid-19 pandemic, while consumer demand remains robust in off-trade sales and the company is also growing market share. The drinks giant is also benefiting from spirits taking share of the total alcohol market.

As such, the company has maintained its earnings guidance going forward. Chief executive Ivan Menezes told investors at the trading statement in October that Diageo remains “well-positioned” to deliver the company’s medium-term guidance. The company expects organic net sales growth in full-year 2023 to full-year 2025 to be consistently in the range of 5% to 7%, and organic operating profit growth of between 6% to 9%.

Analysts at broker Jefferies Financial recently set a target of 4,300p for the shares, while those at Credit Suisse think they could reach 4,400p.

Lloyds Banking Group - benefiting from higher interest rates

Lloyds Banking Group shares are down 1% for the year to 46.48p. However, the bank looks likely to continue to benefit from rising interest rates, while customers are likewise increasing their bank deposits to benefit. What’s more, the poor economic outlook means that consumers are saving more to prepare for the bad times. According to the latest ONS data, the amount of average income that households are saving increased to 9% in the third-quarter from 6.7% in the previous quarter.

In the nine months to the end of September, net income grew by 12% to £13 billion, while customer deposits of £484.3 billion grew by £8 billion during the period and £6.1 billion in the third-quarter. Customer loans and advances rose £7.7 billion to £456.3 billion during the first nine months of the year and by £0.2 billion in the quarter, while the open mortgage book also saw growth.

The CET1 ratio (tier 1 capital ratio), which measures a bank’s financial strength, came in at 15% for the period, well above the bank’s ongoing target of around 12.5%.

Lloyds upgraded its earnings guidance for the full-year. The banking net interest margin is now forecast to be greater than 290 basis points, return on tangible equity to be around 13% and capital generation now expected to be between 225 and 250 basis points.

Meanwhile, the dividend yield is a generous 4.68%, which offers attractions for income seekers. Analysts at broker Barclays think the shares could reach 70p, while those at Deutsche Bank Aktiengesellschaft think they could hit 64p.

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