UK and US markets are intricately linked, with many British-listed businesses deriving much of their revenue from America. So when the economy shifts across the pond, FTSE shares react.
The US Federal Reserve is expected to cut interest rates today (18 September) for the first time in over four years. The benchmark stands at its highest in 23 years following a swathe of hikes to calm pandemic inflation.
Of course, there may be no cut at all, but a meeting is under way to decide on whether the cut will be a quarter or half a percentage point. Depending on what the decision is, it could affect markets differently. A large cut could optimise the economic recovery — but it could also reignite inflation, reversing all of the last four years’ work.
So what effect could all of this have on the UK market?
Ups and downs
The overall goal is to reduce costs and boost employment, therefore reviving the economy. Any boost in the US would likely help our local market improve too.
However, while that’s an ideal outcome, it would be wise to prepare for some volatility.
Defensive shares can provide cushioning during uncertain economic times as they don’t react too much to market changes. Adding a few to a portfolio helps to keep the ship at an even keel when seas get rough.
A defensive defence share
One of my favourite defensive shares is BAE Systems (LSE: BAE). As the largest defence contractor in Europe, it develops and manufactures aerospace and information security services to government and military agencies.
It doesn’t have exceptional growth potential or a high dividend yield. But where it lacks in the promise of returns, it makes up for in stability. It has a clean balance sheet, steadily increasing revenue and around £1.2bn in annual cash flow.
Looking at its chart, we can see that the share price has been quite stable. It didn’t suffer heavy losses during the 2008 financial crisis or Covid in 2020. Many other stocks fell sharply during these periods. Historically, long-term growth has been good, delivering annualised returns of 9.3% over the past 20 years.
It has a forward price-to-earnings (P/E) ratio of 18.3, slightly below the industry average. Analysts forecast price growth of 13% on average over the coming 12 months.
Considerations
BAE has been racking up quite a bit of debt lately. In the first quarter of the year, its debt-to-equity ratio almost doubled to 78%. If this gets too close to 100% it may need to prioritise debt reduction, which could limit funds available for growing the business.
It could also present a moral dilemma for some. As a contractor, BAE’s operations rely largely on government defence spending. It’s a necessary evil but ideally, it would be better if we didn’t need it all. The goal is to find a resolution to global conflicts and reduce defence spending. Naturally, this could lead to slower growth for the company.
Price stability
Whatever the outcome of today’s Fed decision, it can’t hurt to safeguard a portfolio against volatile markets. I believe stable, slow-growing defensive shares are a potentially great way to achieve this.
To maintain stability, I keep about 20% of my portfolio in defensive stocks. Others to consider on the FTSE 100 include AstraZeneca, GSK and Unilever.
