‘Boring’ Blue Chips Lead Record-Setting Market Runup; Bufett’s Bear Doug Kass says when the market is led by defensive stocks, “it is time to be fearful of the broader markets.”

May 5, 2013

‘Boring’ Blue Chips Lead Record-Setting Market Runup



Boring bulls are powering the market higher.

That the stock market has climbed as much as it has this year surprises many analysts. Perhaps the biggest shocker: the kinds of companies leading the charge.

Technology, Internet or other companies making cutting-edge products? Hardly. A group of decidedly unsexy companies—from Procter & Gamble PG +0.55% (PG) and Johnson & Johnson JNJ +0.69% (JNJ) to Colgate-Palmolive CL +0.35% (CL), Clorox (CLX) and General Mills GIS +0.54% (GIS)—are en vogue.Shares of those companies are up from 22% to 32% over the last 52 weeks, far outpacing the overall market. After Friday’s big rally, the Dow Jones Industrial Average is up more than 14.9% in the last year. The Standard & Poor’s 500-stock index is up 17.9%.

Each of the big winners this year is a so-called defensive stock. They tend to have steady earnings in almost any kind of economy, though they don’t usually see huge surges in sales.

Big stock-market rallies usually are led by so-called cyclical stocks, such as industrial and transportation companies, as well as those selling discretionary consumer products, such as entertainment giant Time-Warner or Chili’s restaurants parent company Brinker International EAT +2.37% . These are the companies that usually see profit improvement in a rebounding economy. These stocks led the market higher last fall, following this usual pattern.

Around February, though, the market’s leadership changed, notes James Paulsen, chief investment strategist at Wells Capital Management. Defensive sectors that investors usually cling to in troubled times, such as utilities, companies selling consumer staples and health-care shares, became the market giants.

Instead of piling into shares in expectation of strong earnings growth, investors bought up the safest stocks, unable to bring themselves to embrace risk. Investors want to own shares and yet protect their portfolios, Wall Street’s version of having some cake and eating it, too.

When the junk-bond market trades at a yield of less than 6%, a dividend of about 3% on Johnson & Johnson and Clorox, which are perceived as safe companies in reliable industries, looks attractive to many investors.

“Speculative-grade bonds do not offer good value,” says Martin Fridson, chief executive officer of FridsonVision, a financial research firm based in New York. Investors sharing Mr. Fridson’s view may be putting money in stocks with hefty dividends, analysts say, though others continue to buy up junk bonds.

Defensive stocks are being purchased by “reluctant stock buyers,” says Jack Ablin, chief investment officer of BMO Private Bank. “In other words, would-be bondholders who have been prodded off the plank into the equity market. They’re looking for yield and stability.”

Slowing Economy

So far this year, health-care shares are up nearly 19%, consumer staples are over 17% higher and utilities are up 17%—all well above the overall market. Meanwhile, shares of materials companies, such as Dow ChemicalDOW +2.54% or energy company Continental Resources, are up less than 4%, while information-technology stocks are up about 6%.

Mr. Paulsen says the shift began when data emerged suggesting that the U.S. economy is slowing. Instead of selling shares, though, and moving money into low-yielding bonds or cash, investors decided to shift to safer stocks, many with sizable dividends.

Some investors are concerned. Douglas Kass of Seabreeze Partners Management says when the market is led by defensive stocks, “it is time to be fearful of the broader markets.”

If defensive stocks are outperforming those that are more dependent on the economy’s growth, it could be signal from the market that a slowdown is ahead, these investors argue.

Indeed, prices of U.S. Treasurys and other safe bonds also have been climbing lately, a relatively unusual occurrence when stocks have rallied and one that could suggest a fear of the economy’s outlook.

Recent indications that the Chinese economy is cooling, and weakness in commodities tied to growth in emerging-market nations, also are warning signs to some analysts.

And cyclical stocks can be tricky to own. Energy shares, for example, should do better as the U.S. economy expands. But because there’s been a surge of U.S. oil and gas supply, a phenomenon that could weigh on future energy prices, some are wary of these stocks.

But Tobias Levkovich, Citigroup‘s C +0.92% chief U.S. equity strategist, says it’s a mistake to view the market as hostile to all cyclical shares.

He says investors are souring on companies reliant on global growth, due to continuing concerns about Europe and emerging-market nations. But they’re buying up stocks benefiting from the relatively strong growth in the U.S., such as housing-related shares. “The real split seems to be more geographic in nature,” he says.

Apple’s Woes

Indeed, consumer discretionary stocks aren’t exactly taking on water. They’re up 15.5% in 2013. At the same time, the technology sector is being weighted down by the poor recent performance of Apple, which has more to do with concerns the giant won’t be able to maintain its breakneck earnings growth than it does any worries about the overall economy.

For investors, shifting to safer stocks has danger, despite the relative stability of their businesses, partly because these companies often have more challenges growing their businesses.

Shares of pharmaceutical giant Pfizer PFE -1.06% (PFE) led the market through much of the year, rising over 20% in 2013 through Monday.

But on Tuesday, Pfizer reported a 9% revenue decline in the first quarter and lowered its full-year outlook as new drugs have yet to contribute meaningful sales, despite cost cutting and asset sales. Pfizer shares fell on the report—though they remain up 29% on the last 52 weeks.

Meanwhile, many of the seemingly safe stocks trade at expensive prices. Clorox, for example, has a price-earnings multiple of about 18.5, much higher than the market’s overall P/E ratio of about 14.

Indeed, Mr. Levkovich warns investors to be wary of health-care shares on the heels of their recent impressive performance because some now seem overpriced. He’s a bigger fan of shares of utilities.

At the same time, cyclical shares have done a bit better than defensive companies in the last few weeks, suggesting to some analysts, such as Mr. Paulsen, that a change could be afoot if the U.S. economy proves resilient.

“I don’t think economic momentum has slowed as much as most believe” and think that most of the recent weakness is due to temporary issues, such as a nasty weather, that will abate, Mr. Paulsen argues.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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