WITH markets around the world trading at all-time highs, investors are clearly getting nervous about a market correction.

In a normal cycle, investors would try to protect their portfolio by buying defensive shares. But this has been anything but a normal cycle - so will this strategy work this time?

The synchronised global liquidity provided by central bankers through their policies of low interest rates and quantitative easing (QE) has led to developed market bond yields being at very low levels versus history.

This has had significant positive implications for all risk assets. One interesting and completely counterintuitive fact is that since QE started in 2011 it has been defensive shares such as consumer staples that have led markets higher. This is most unusual as normally higher-beta more cyclical shares would lead a rising market.

This does make some sense when you consider the almost perfect inverse correlation between the share price performance and bond yields of consumers staples, which is why they have been called bond proxies. But what that means is that defensive shares now trade at both a significant premium to the market and to their history.

The key question is, therefore, can these re-ratings be justified by the operating performance of the business?

Coca-Cola has re-rated from a price-earnings ratio of 16 times to 24 times since 2011. This feels counterintuitive when set against the rise in health-conscious millennials and global taxes on sugary drinks.

Indeed, on closer examination it is even more surprising. Since 2012, Coke’s earnings forecast has fallen almost every year, with 2017 earnings expectations 12 per cent below the 2013 forecast. In order to keep its dividend yield at around three per cent, its dividend pay-out ratio has increased significantly and its balance sheet leverage has more than doubled. This is not sustainable in the long run.

This is not just a Coca-Cola-specific issue. Recent third-quarter statements from the global consumer staples companies on the whole were disappointing.

Reckitt Benckiser reported negative like for like growth of minus one per cent and Unilever grew sales by 2.6 per cent, although the latter was driven by increasing prices as volumes were in effect flat. Proctor and Gamble, meanwhile, grew its top line by a mere one per cent during the third quarter.

It is clear that organic growth rates are slowing as consumers are switching away from multinational products.

As we look to the future, the industry is facing long-term structural issues such as the changing consumption habits of millennial consumers, lower barriers to entry, and online competition. All of these factors will limit these companies’ ability to increase prices and volumes.

In addition, the craze in staples is zero-based budgeting, which results in drastic cost-cutting exercises, especially in marketing and advertising. The aim is to help hit margin targets, especially as input costs turn into a headwind after being beneficial for the last three to four years.

However, in our opinion, cutting advertising spend is the wrong strategy for long-term health and growth in brands volumes. Kraft Heinz is a great example where marketing spend was cut almost in half only to be followed by zero revenue growth for the next three years.

In our opinion, a backdrop of continued soft trading, high valuations and normalising bond yields should result in these expensive defensives de-rating from current levels. It is interesting to note that this de-rating has already started and is particularly evident in the US. In Europe, the trend is less evident but it can surely only be a question of time before the shares start to de-rate.

David Keir is executive director at Saracen Fund Managers.