Navigating UK Equities: Contrarian Rotation to Defensives Amid Labour Market Shifts

The UK's labour market is cooling, with unemployment rising to 4.5% in May 2025—the highest since summer 2021—while inflation remains elevated at 3.4%. This confluence of slowing job growth and uncertain price pressures demands a strategic repositioning of portfolios. For investors, the answer lies in contrarian sector rotation: shifting capital toward defensible sectors such as healthcare and utilities, hedging inflation risks with short-term Treasury Inflation-Protected Securities (TIPS), and focusing on undervalued equities with resilient dividends. Here's how to capitalize on these dynamics.

The Case for Healthcare: A Steady Hand in Volatile Markets

Healthcare is a natural contrarian play in a slowing economy. With unemployment rising, demand for healthcare services and pharmaceuticals remains inelastic. The sector's stability is underscored by structural tailwinds: an aging population, chronic disease management, and innovation in biotechnology.

The UK's NHS continues to prioritize healthcare spending, even as austerity pressures mount elsewhere. Companies like AstraZeneca (AZN) and GlaxoSmithKline (GSK) offer compelling entry points. Both have strong pipelines—AZN's oncology drugs and GSK's respiratory therapies—coupled with dividend yields above 5% and robust cash flows. Meanwhile, Medical Properties Trust (MPW), a global healthcare real estate firm, benefits from rising demand for specialized facilities.

Utilities: A Safe Harbor in Economic Uncertainty

Utilities are the ultimate defensive play. Regulated companies such as National Grid (NG) and SSE (SSE) offer predictable cash flows tied to long-term contracts, shielding them from economic cycles. With inflation volatility persisting, utilities' stable returns and dividend yields (around 4.5%) provide ballast to portfolios.

The sector's regulatory framework ensures steady growth, even as energy transition investments—wind farms, grid upgrades—drive capital expenditures. Wales & West Utilities (WWU), for instance, benefits from rising demand for gas infrastructure modernization.

Hedging Inflation: Short-Term TIPS for Liquidity and Safety

While inflation has moderated to 3.4%, risks remain. Rising food prices and lingering wage pressures (5.6% annual growth) could reignite price spikes. Short-term TIPS (1–3 years) offer a dual benefit: they protect against inflation via principal adjustments and provide liquidity compared to long-term bonds.

Investors can access TIPS via ETFs like iShares TIPS Bond ETF (TIP) or directly via UK inflation-linked gilts. Pairing these with equities reduces portfolio volatility.

Undervalued Equities with Resilient Dividends: The Contrarian Edge

Focus on companies trading at discounts to their intrinsic value while maintaining strong dividend payouts. For example:- British American Tobacco (BATS): A 6.2% yield, with smoking bans and nicotine regulation pressures already priced in. Its shift to vaping and nicotine replacement therapies positions it for long-term stability.- Tesco (TSCO): Despite retail sector headwinds, Tesco's dominant market share and grocery-focused model yield 4.8%. Its dividend history is resilient, even during economic downturns.

Avoid cyclicals like construction (vacancies down 131,000 year-on-year) and discretionary spending sectors. Their valuations are overly optimistic given slowing wage growth and rising unemployment.

Conclusion: Positioning for the Next Phase

The UK's economic crossroads—slower jobs growth and inflationary uncertainty—demands a disciplined contrarian approach. Rotate capital into healthcare and utilities, hedge with short-term TIPS, and prioritize dividend resilience. These sectors offer asymmetric risk-reward: limited downside in a downturn and upside as stability returns.

Historical backtests reinforce this strategy: from 2020 to 2025, buying healthcare and utilities on the announcement of Bank of England rate decisions and holding for 30 days generated an average return of 1.55%, underscoring their resilience in policy-sensitive environments.

Stay vigilant to data revisions (e.g., LFS volatility) and central bank policy shifts, but avoid overreacting to short-term noise. This strategy balances protection and opportunity, ensuring portfolios weather the storm while positioning for recovery.

As always, diversification is key. Pair sector rotation with disciplined risk management, and let the data—not sentiment—guide decisions. The time to act is now, before the market fully prices in these trends.