As the stock market rally reaches to new highs, it may be time to re-allocate a portion of capital to a few top defensive equities to help manage risk should this uptrend grow weary.
First, let’s take a long-term look at staples vs. discretionary stocks. Below is a weekly chart of staples vs. discretionaries and their relative performance vs. the S&P 500. The indices are the S&P 500 Consumer Staples Sector Index (SPST) vs. the S&P 500 Consumer Discretionary Index (SPCC). As is obvious and expected following the "Great Recession," Consumer Discretionary stocks (purple line) have outpaced defensive Staples (orange line) since the market bottom in 2009. Staples have graced a trading range since 2010, with a rather marked setback in relative performance this year, since April 2013.
As discretionary stocks have outperformed staples, so too has growth trounced value, generally spanning the period from the 2009 market bottom to today. An interesting to note, however, is that the relative strength of growth vs. value has not participated recently in the new highs of the S&P 500. In the chart below, we depict the Russell 2000 Growth index (RUO), vs. The Russell 2000 Value index (RUJ). You can see the peak in the Growth/Value ratio achieved this October, corresponding with a peak in its Relative Strength Index (RSI) from an overbought condition.
How do we tactically respond to these signals in our portfolio allocation strategies? Considering the gains on the equity markets during 2013, taking profits or shifting out of high-beta growth equities into more defensive long positions may be in order, especially considering the age in this market uptrend, which will be five years old this March.
We ran a screen of equities that sported the following “defensive” characteristics but that represented companies with solid fundamentals. Here is the screening criteria:
- Beta 0.8 or under
- Return on Equity of 10% or higher
- Record of positive earnings surprises
- Price to cashflow of 10 or lower
- Dividend yield of 1.5% or higher (we omitted utilities due to interest rate risk).
We then pared the list to a mix of equities of companies representing a diversity of industries as well as stocks that were technical-attractive. Here is what we found:
While there is no guarantee that discretionary stocks won’t continue their steadfast ascent, diversifying one’s portfolio with a handful of defensives such as those above, is a prudent approach to equity allocations.
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- Baseline Analytics