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The Rotation Into Defensive Stocks Continues


Consumer staples and food and beverage stocks have been solid outperformers.

This article was originally posted on the Buzz & Banter where subscribers can follow over 30 professional traders as they share their ideas in real time. Want access to the Buzz plus unlimited market commentary? Click here to learn more about MVPRO+.

Since February 19, the S&P 500 (INDEXSP:.INX) has been in an obvious trading range.

I mentioned the possibility of a range forming in my February 20 piece on the Buzz & Banter [subscription required].

Ranges can be wide or narrow and go on for long or short durations of time.

They can develop to digest recent moves, to allow for fundamentals to catch up to valuations, to form tops, or simply because there isn't a clear-enough picture as to where things are headed.

When the market gets an indication that something is changing, probabilities get calculated, valuations get adjusted based on new expectations, and the range will be broken either to the upside or to the downside.

However, it's always important to look underneath the major indices and take note of the sectors that comprise the market as a whole. After all, a house is only as strong as its frame. 

Since the middle of February, I've been seeing and noting many divergences and dislocations occurring under the surface. Divergences and dislocations to this extent are the market subtly telling you its opinion. For example, large-cap names that pay a respectable dividend, represented by the Dow Jones Select Dividend ETF (NYSE:DVY) have been outperforming since the beginning of March with a choppy but still present uptrend. You'd expect the major indices such as the S&P 500 (INDEXSP:.INX) & Dow Jones Industrials (INDEXDJX:.DJI) to be performing roughly the same, but so far they haven't. 

Since the beginning of the year, utilities and preferreds have been nothing short of rocking, and defensive sectors such as consumer staples and food and beverage have been massively outperforming. 

Heck, Procter & Gamble (NYSE:PG) had not-so-great guidance a few days ago, and before we knew it, it was trading two points higher from before the report. Even the sleepy REITs have been slowly creeping higher. Lest we forget, numerous high-beta and high-multiple names peaked in late February to early March. I don't mean to toot the horn too much, but that call was nailed here on the Buzz [subscription required].

Ranges are present in many sectors such as aerospace, chemicals, delivery services (e.g., Fedex (NYSE:FDX) and UPS (NYSE:UPS)), hotels, railroads, semiconductors, and basic materials.

Sectors that are a little more concerning at the moment include financials, retail, heavy construction, homebuilders, and home improvement.

Over in Europe, the FTSE 100 (INDEXFTSE:UKX) has been in range for about six months, with the DAX Performance Index (INDEXDB:DAX) having been in a range since mid-December.

Ten-year Treasury yields are currently at the low end of the range that they've been in since the beginning of February.

The answer as to why money has been flowing into high-yield and defensive names isn't too hard to figure out. Economic growth expectations for 2014 started to be negatively discounted in mid-February and early March because of weather and continuing issues in China. 

For the moment, the Russia/Ukraine issue is a small variable insofar as it creates political tensions with Russia and potential energy supply issues in Europe.

Could it just be the weather issue? Sure, but the market isn't ignorant to the weather. Remember that equity, credit, and commodity markets are discounting mechanisms -- they trade based on future expectations, which change regularly.

What the markets are trying to figure out is whether the economy started to recover on a steady trajectory in April. Or is economic growth (and inflation) simply not going to be what was priced in? Maybe the low 2% growth range rather than high 2%? 

Soon we'll start adjusting valuations for blended 2014 and 2015 numbers. That will likely be what dictates the direction of the next trend in equity land. I'm also watching high-yield credit spreads (option adjusted), but there's nothing to report there as of yet. They're bumping around 3.75%.

I'm currently in the camp of valuation adjustment and digestion. What will change the markets' state of mind and sideways action? Two things: time and new information. Without those inputs, the market is stuck in a mode of unknown. Unknown isn't a bad thing per se. However, if we enter into a stage of uncertainty, then that will be dealt with and discounted much differently.


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