Time To Get Defensive?

April Joyner of Reuters reports, Trade Policy Uncertainty Could Bolster U.S. Defensive Stock Sectors:

As the United States ramps up import tariffs and long-date U.S Treasury debt yields remain low, stocks in so-called defensive sectors may have room to run higher in price, even though expectations for the currently quarterly earnings seasons are high.

Stocks in defensive sectors, which generally pay steady dividends and have steady earnings, languished for the first months of 2018. Utilities, real estate, telecommunications and consumer staples all saw their stocks fall into early June even as the U.S. benchmark S&P 500 index rose more than 4 percent.

But over the past 30 days, two of those sectors have led the S&P 500 in percentage gains as geopolitical risk has risen.

Utilities have jumped 7.7 percent, and real estate has gained 3 percent. Not far behind, consumer staples have risen 2.5 percent. All have outperformed the S&P's 0.4 percent advance.

By contrast, shares in several cyclical sectors, which tend to rise as the economy grows and are often favored by investors in the late stage of a bull market, have dropped over the same period. Industrials have slumped 3.9 percent, while materials have slid 3.6 percent and financials have fallen 2.7 percent.

Several conditions have supported a rotation into defensive stocks, investors said.

They tend to perform better when interest rates are low, and they have risen as yields on the 10-year Treasury note have retreated from the 3.0 percent mark since early June.

A burgeoning U.S. trade war with China and the European Union has also led investors to seek stability. On Tuesday, the White House proposed 10 percent tariffs on an additional $200 billion worth of Chinese goods.

Consumer staples stocks also got a boost on Monday after PepsiCo Inc reported better-than-expected quarterly results.

Seven out of 25 of the S&P 500 consumer staples companies have reported so far, and of those, 86 percent have beaten analyst estimates for revenue and profit. Generally, staples and other defensive areas lag the other S&P 500 sectors in revenue and earnings growth.

Some market watchers have begun to recommend portfolio adjustments in anticipation of a downturn in U.S. stocks.

On Monday, Morgan Stanley's U.S. equities strategists upgraded consumer staples and telecom stocks to an "equal weight" rating, after raising utilities to "overweight" in June. They downgraded the technology sector, which accounts for more than a quarter of the weight of the S&P 500, to "underweight."

"We expect the path to be bumpy for the next few months," said Keith Lerner, chief market strategist at SunTrust Advisory Services in Atlanta, which in May added exposure to real estate stocks in one of its portfolios. "Having some dividend strategies is likely to be a nice ballast."

Few investors believe the end of the bull market is imminent though.

Some said the gains in defensive sectors are bound to be short-lived as strong corporate earnings and continued economic strength boost market sentiment. Others believe recent tensions between the U.S. and China over trade policy will be resolved by the autumn as the U.S. midterm Congressional elections approach.

"We have solid earnings growth, and we have an economy that continues to march down the path of acceleration," said Emily Roland, head of capital markets research at John Hancock Investments in Boston. "Those (defensive) sectors are not attractive to us."

Even so, defensive sectors could draw investors' attention in the next few months if stock markets remain choppy. As they have languished in the past few years, stocks in those sectors could offer value, especially if the companies raise dividends, said Kate Warne, investment strategist at Edward Jones in St. Louis.

The improving performance of stocks in defensive sectors may ultimately be beneficial for the market, some investors said.

The lion's share of growth in the S&P 500 index has come from technology and consumer discretionary stocks: most notably, Facebook Inc, Amazon.com Inc, Netflix Inc and Google parent company Alphabet Inc, collectively known as FANG.

If other sectors can contribute more to the index's gains, investors may have more confidence in diversifying their portfolios.

"With a very narrow market like you've had most of this year, it's great for stock pickers, but it's hard for indexes to make money," said Robert Phipps, a director at Per Sterling Capital Management in Austin, Texas. "What you're seeing is a broadening out of the market, which is extraordinarily helpful."

Since the beginning of the year, I've been telling investors the theme this year will be the return to stability, borrowing off the wise insights of François Trahan at Cornerstone Macro.

So far, tech stocks (XLK) are on fire and while some fear another dangerous tech mania is upon us, François Trahan correctly predicted the surge in tech shares is all part of a much bigger Risk-Off defensive trade.

Nevertheless, while the environment is Risk-Off, many safe dividend sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ) got hit earlier this year as long bond yields rose and investors got all nervous about the bond teddy bear market.

As of June, however, long bond yields have declined and these defensive sectors are coming back and the media thinks it's mostly due to rising trade tensions. 

It's not. Don't get me wrong, mounting trade tensions aren't bullish and they will exacerbate the global downturn but the downturn began long before Trump started slapping tariffs on America's allies and China. 

The downturn is part of the cumulative effect of Fed rate hikes which is why I keep warning my readers not to ignore the yield curve. 

I know, the media will tell you not to fear the flat yield curve and financial websites will tell you the yield curve panic is overdone, but I'm telling you the US and global slowdown is already here and you need to pay very close attention to the yield curve and ignore those who tell you otherwise.

It doesn't mean that markets are going to tank the minute the yield curve inverts, it means risks are rising and allocating risk wisely is going to become harder and harder in an already brutal environment. 

Sure, you can buy Netflix (NFLX) before the company announces earnings on Monday and who knows, you might make a killing if the company reports blowout numbers again, as any good news will drive shares higher to a new 52-week high (click on image):

If it disappoints, however, it will get crushed, especially after a huge run-up this year. 

This is becoming a stock picker's market, which is a good thing. Tracking top funds' activity every quarter, I can tell you many interesting tidbits like who's buying what stocks, who's making money, who's losing money and on what specific trades.

And it's not always high-profile stocks you should be looking at. Warren Buffett, Bill Miller, John Paulson, Steve Cohen may not have much in common but they and others have made decent money playing generic drug stocks and big pharmaceuticals like Teva Pharmaceuticals (TEVA), Mallinckrodt (MNK), Endo International (ENDP) and Novartis (NVS).

Unfortunately, Buffett is getting killed on Kraft Heinz (KHC) this year, one of his biggest holdings in consumer staple stocks but that stock has done well recently (click on image):

What else has done well recently? US long bonds (TLT) which tells me investors are starting to worry about the sell-off in emerging markets (EEM) and whether global weakness will spread throughout the world (click on images):

After the yuan's recent sharp decline, markets are nervous that China intends to wield its currency as a weapon in its trade tussle with the US but some say while the worries are understandable, they're overblown as Beijing stands to lose more than it would gain by devaluing the yuan.

Right now, if I were recommending where to allocate risk, it would be in defensive sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ). And I would hedge that stock exposure with good old US long bonds (TLT).

Who knows, we shall see, I'm defensive in my recommendations but still see a lot of risk-taking activity in biotech and other names I track and trade. These were some of the stocks on my watch list which popped big on Thursday (click on image):

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Some of them like Galmed Pharmaceuticals (GLMD) and Zogenix (ZGNX) surged this week and are having an outstanding year

I'm sharing this with you because I track stocks every day, lots of stocks, and it's hard for me to be ultra bearish when I see many risky stocks making huge gains.

Below, the S&P 500 posted on Friday its best closing level since early February as shares from some of the largest tech companies hit record highs. UBS's Art Cashin and CNBC's Bob Pisani discuss factors impacting the markets today.

And Scott Minerd, Guggenheim chief investment officer, discusses the economic impact of a potential trade war. Marc Mobius also appeared on Bloomberg this week stating the trade war is just a warm-up to the financial crisis.

Take all the gloom & doom talk about trade wars with a grain of salt. The global economy is slowing, it's a good time to get defensive but it's not time to panic, at least not yet.