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Stock Investors Torn as Defensive Bets Go 'Absolutely Parabolic'

Stock Investors Torn as Defensive Bets Go 'Absolutely Parabolic'
(Christy Thompson/Dreamstime)

Monday, 24 June 2019 09:58 AM EDT

Jerome Powell and his colleagues are stoking U.S. stocks to fresh records, but they’re also sharpening the valuation dilemma confronting investors the world over.

The prospect of easier monetary policy is adding fuel to a mammoth rally in bond proxy shares like real estate companies and utilities. Investors betting on a growth slowdown are ramping up premiums for U.S. defensive stocks to the most in six years, as high-quality equities in Europe also notch fresh records. Companies that post reliable earnings -- growth stocks -- are at a two-decade high versus value shares.

In other words, the late-cycle conundrum is spurring some of the biggest equity market schisms across Europe and the U.S. in decades, and it’s prompting warnings a rotation is nigh. Now signs are emerging that the smart money and key-name funds are cutting exposures to expensive defensives.

“Valuations are pretty stretched,” said Frederic Jeanmaire, a portfolio manager at Columbia Threadneedle, whose European fund has returned nearly double its benchmark this year. The firm has now taken profit on rate-sensitive defensive shares and added more cyclical names. “We don’t have a strong view that interest rates are going to go much lower.”

It’s all part of an economic landscape that’s troubling investors and policy makers alike. While inflation expectations have collapsed and bonds markets project even more rate cuts than the Federal Reserve does, there are still few signs a recession is imminent. So are these defensive equities worth an ever-increasing price?

The Fed’s likely success in steepening the yield curve -- which tends to benefit financials and value equities -- should help spur a recovery in cyclicals “barring a sudden recession,” Evercore ISI strategists led by Dennis DeBusschere wrote this week.

Sector rotations last week underline the conflicted picture. While rate-sensitive defensive sectors took charge right after Powell’s dovish turn, cyclicals including industrials and materials were the big winners the day after as investors turned to cheaper corners of the market.

Among the smart-money crowd, a rotation appears to be afoot.

Hedge funds have cut their net exposure to rate-sensitive defensive stocks by adding shorts, according to Credit Suisse Group AG’s prime brokerage. And although they maintained low net exposure, they also increased their tilts toward more cyclical names, especially financial stocks, according to Masanari Takada, a quantitative strategist at Nomura Holdings Inc.

Where investors go from here will hinge on progress in U.S.-China trade talks. Until then, the extreme valuation gap between defensive and cyclical stocks isn’t enough to spell a rotation for everyone. After all, stocks boasting faster earnings expansion have beaten value names consistently for more than a decade now thanks to historically low rates and tepid economic growth.

“What the last several years have proven is that valuation polarization can last for longer than one imagines,” said Paul Markham, a fund manager at Newton Investment Management who’s sticking to his growth bets.

Exchange-traded funds in the U.S. tracking growth have drawn $3.4 billion of inflows this month, the strongest since at least 2013.

All the same, Jeanmaire at Columbia Threadneedle has taken advantage of trade concerns to snap up shares of cyclical names including DSV A/S, Linde Plc and Sika AG.

And though his fund’s quality growth style means he’s almost always underweight on financial stocks -- in Europe, they’re at a record low versus the benchmark -- the extreme underperformance has prompted him to dial back their bearish stance.

“If you include the fact that maybe some investors will be concerned about the cycle, we think we can get these companies a bit cheaper than say some purely defensive companies with yield sensitivities, which have literally gone absolutely parabolic,” he said.

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Jerome Powell and his colleagues are stoking U.S. stocks to fresh records, but they're also sharpening the valuation dilemma confronting investors the world over.
stock, investors, bet, defensive
Monday, 24 June 2019 09:58 AM
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