As equities reach to new highs, it may be a prudent time to shift a portion of capital to a few top defensive equities to help manage risk should this uptrend show signs of growing weary.
First, let's take a long-term look at staples vs. discretionary stocks. Below is a weekly chart of staples vs. discretionary stocks 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 pronounced setback in relative performance since April of this year.
Just as discretionary stocks have outperformed staples, growth has trounced value, spanning the period from the 2009 market bottom to today. It is noteworthy, however, 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 have a ratio of 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 to a peak in its Relative Strength Index (RSI) from an overbought condition.
Considering the gains in the equity markets during 2013, taking some profits and shifting capital out of high-beta growth equities into more defensive positions may be in order.
To identify some defensive diversification, we ran a screen of equities that sported the following "defensive" characteristics with attractive fundamentals. Here is the screening criteria:
· Beta 0.8 or under
· Return on equity of 10% or higher
· A consistent record of positive earnings surprises
· Price to cashflow of 10 or lower
· Dividend yield of 1.5% or higher (we omitted utilities from our screener 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 technically-attractive. Here is what we found:
To further pare the list, we sorted the above list by PEG ratio (Price-to-Earnings growth) to identify value at a reasonable price. Since these companies typically report better-than-expected earnings, we reasoned that a PEG ratio, which includes forward-looking earnings estimates, would be fairly accurate. Our initial list of equities sported a 2.35 average PEG ratio. We selected those that had a PEG ratio lower than this average, and arrived at the following stocks and their PEG ratios:
Time Warner (TWC): 1.22
Wal-Mart (WMT): 1.78
ProAssurance (PRA): 0.93
Rogers Communications (RCI): 2.28
Of the above, Time Warner has been volatile over the last few weeks, given the recent buzz about a deal with Comcast. Its chart is technically strong:
Rogers Communications has hugged its 50-day moving average since gapping up in September:
(click to enlarge)
ProAssurance stock corrected 22% since July due to a disappointing earnings report (following four quarters of estimate-beating earnings announcements. The stock appears to have found support at its 50-day moving average.
Wal-Mart broke above resistance in the 78 area (look for that level to provide support).
Baseline Analytics reviews over 5,000 companies each week to identify attractive stocks with favorable fundamental and technical criteria. We often review sectors and investment styles that may be contrary to current bullish enthusiasm to find overlooked nuggets of opportunity.
While macro and technical market conditions continue to support the uptrend, and higher-beta growth equities may continue to ride the wave higher, diversifying one's portfolio with a handful of defensive stocks such as those above is a prudent approach to equity allocation.
- Baseline Analytics