Booming bond yields: I'd still buy these 3 defensive ASX stocks instead

Bonds might be offering a 'risk-free' return of 4.6%, but they lack a unique advantage of investing in defensive companies.

| More on:
Two mature women learn karate for self defence.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

It is an unrelenting bloodbath in the Australian share market today. The S&P/ASX 200 Index (ASX: XJO) is tumbling 1.38% lower as investors reflect on surging bond yields.

Now at heights not seen in more than a decade, the generous yields on US and Australian bonds are undoubtedly prompting more people to consider whether the higher volatility associated with stocks is worth it.

At an almost 5% yield on a 10-year bond, some investors are likely cashing out of equities and allocating more capital to the debt instrument.

Hence, even defensive stock stalwarts such as Telstra Group Ltd (ASX: TLS) and Transurban Group (ASX: TCL) are coming under pressure today, along with roughly 85% of the other top 200 listed companies.

So, what's going on with bond yields?

Bond yields are back on the table

Between 2015 and early 2022, Australian 10-year Government bonds yielded less than the upper band of the Reserve Bank of Australia's target inflation rate of 3%. An era of ultra-low interest rates meant debt was cheap — which was great for borrowers but pushed income seekers away from debt markets.

Times have since changed, leaving central banks to tussle with sticky inflation.

Australian 10-year Government bond yields are now around 4.6% — the highest in 12 years. Likewise, the yield on a United States Treasury bond is in the vicinity of 4.7%, a level not witnessed since October 2007.

In short, three key drivers are influencing these burgeoning yields:

  1. Downgraded credit rating: Fitch Ratings lowered its AAA rating on the US government to AA+ in August. The perception of increased risk can impact the bond price, increasing its yield.
  2. Higher for longer interest rates: Jerome Powell, the chair of the US Federal Reserve, and others have indicated interest rates could remain elevated for an extended period.
  3. Issuance of more bonds: More bonds are being issued to fund government programs. An increase in the supply of bonds weighs on the price, bolstering yields.

The circumstances have fuelled views, such as those shared by Christopher Joye of Coolabah Capital, that the yields from bonds are a better proposition than equities over the next few years.

Three defensive ASX stocks I'd buy over bonds

Opting for less volatile returns from bond yields might be attractive in the short term. However, many historical examples show that real wealth is often created by the compounding effect over long periods of time.

Famed billionaire investor Terry Smith explained the compelling nature of defensive stocks in 2017, writing:

Equities can compound in value in a way that investments in other asset classes, such as bonds and real estate, cannot. The reason for this is quite simple: companies retain a portion of the profits they generate to reinvest in the business.

In my opinion, savvy investors can still derive exceptional returns from good companies listed on the ASX, rather than bailing to bonds. Not all companies can be tarred with the same brush.

Companies with modest debt levels, resilient products and/or services, trading on a free cash flow (FCF) yield — the cash generated after all expenses divided by its market capitalisation — of around 5% or more, still provide a more appealing long-term option, in my view.

The ASX defensive stocks I believe meet this criteria are Steadfast Group Ltd (ASX: SDF), Jumbo Interactive Ltd (ASX: JIN), and Coles Group Ltd (ASX: COL). Importantly, these three companies operate in industries that keep ticking through hard times — insurance broking, lottery tickets, and groceries.

Each of these companies trades on an FCF yield of 4.9% or more. In essence, investors in these companies are already 'earning' a superior return than current bond yields. Furthermore, each has the ability to reinvest and compound, unlike bonds.

Motley Fool contributor Mitchell Lawler has positions in Jumbo Interactive. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Jumbo Interactive, Steadfast Group, and Transurban Group. The Motley Fool Australia has positions in and has recommended Coles Group, Steadfast Group, and Telstra Group. The Motley Fool Australia has recommended Jumbo Interactive. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Defensive Shares

Men standing together and defending the goal post symbolising defensive shares.
Defensive Shares

5 top defensive ASX shares for turbulent times

These stocks could be long-term defensive winners.

Read more »

a child dressed in army fatigues lies on the ground in his backyard wearing leaves and branches on his head as camouflage and peering through a pair of binoculars in a soldier pose.
Defensive Shares

Searching for defensive ASX shares? Here's what I look out for

Not all defensive companies make for good investments.

Read more »

two men smiling with a laptop in front of them, symbolising a rising share price.
Defensive Shares

'Attractive valuations': 2 ASX 200 shares set for 'strong performance' while the world crumbles

The Wilsons team reckons these two monopolies could do the trick during uncertain economic and geopolitical times.

Read more »

A woman ponders over what to buy as she looks at the shelves of a supermarket.
Defensive Shares

The pros and cons of buying Woolworths shares in October

Is inflation becoming a headwind for earnings?

Read more »

Concept image of man holding up a falling arrow with a shield.
Defensive Shares

3 ASX shares I think could help hedge against a stock market crash

These stocks could provide investors with defence.

Read more »

Men standing together and defending the goal post symbolising defensive shares.
Defensive Shares

7 mighty companies I'd invest in to build a defensive ASX portfolio

Here's how I would build a defensive share portfolio today.

Read more »

a child dressed in army fatigues lies on the ground in his backyard wearing leaves and branches on his head as camouflage and peering through a pair of binoculars in a soldier pose.
Defensive Shares

'Quality defensive': 2 ASX 200 shares for a battle-ready portfolio

Check out these stock tips from Baker Young Toby Grimm for resilient growth through economically depressed times.

Read more »

RIO BHP Profit upgrade A business man open his shirt to reveal a superhero style $ on his chest, indicating a strong ASX share price
Defensive Shares

3 resilient ASX shares to help fortify your portfolio

These could be the defensive shares to buy in the event of a recession.

Read more »