domingo, 23 de noviembre de 2014

domingo, noviembre 23, 2014
Playing Defense All Around The World
             


Summary
  • Many investors today are feeling conflicted.
  • In one respect, they see a U.S. stock market that appears completely unyielding in its persistence to the upside.
  • On the other hand, they see a stock market that may soon be left exposed to the downside without the crutch of more QE from the Fed.
  • Playing defense all around the world may provide a way to participate in further stock upside while also protecting against the downside.

Many investors today are feeling conflicted. In one respect, they see a U.S. stock market that appears completely unyielding in its persistence to the upside despite the fact that we will soon be entering the sixth year of what is currently the third longest bull market in history. As a result, they want to participate in any further upside stocks have to offer. On the other hand, they see a stock market that will soon be entering the sixth year of a bull market on what has been more than dubious fundamentals all along and that has just now lost the monetary policy fuel from QE related asset purchases that helped propel it higher for so many years.
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Consequently, they are reluctant to participate any further amid the fear that they might be committing fresh capital to the market just as the graying bull market is finally coming to an end. What is the conflicted investor to do? One possibility is to consider playing defense all around the world.

The defensive leadership in today's market must be a point of concern for the bulls. For the year to date, the U.S. stock market has been driven higher primarily by its defensive sectors.

This includes health care (NYSEARCA:XLV) at +24.5%, utilities (NYSEARCA:XLU) at +23.3% and consumer staples (NYSEARCA:XLP) at +14.8%. Putting this leadership into context, the only cyclical sector that is up double-digits year to date is technology (NYSEARCA:XLK) at +17.4%, while the rest are only up single-digits with the exception of energy (NYSEARCA:XLE), which is down -1.1% for the year. The reason this defensive strength may be disconcerting for the bulls is because these are sectors that typically assume leadership at the very late stages of a bull market at or near (or even after) broader market peaks.

The strong performance of defensive stocks in 2014 presents a fresh new conundrum for the more reluctant investor. Perhaps allocating to these more defensive sectors has appeal in working to manage risk while still participating in further market upside. But the fact that these sectors have performed so strongly this year may leave the investor questioning whether they have at this point missed the upside associated with such positioning at this stage. After all, these sectors now appear fairly expensive from a valuation standpoint with price-to-earnings ratios of 20.0, 18.7 and 17.7 for the consumer staples, health care and utilities sectors, respectively. As a result, these sectors may now be just as exposed as their more cyclical counterparts to a sudden downside move given these premium valuations. Thus, investors may be left to look elsewhere to explore establishing such defensive exposures.

The recent divergence between U.S. and non-U.S. defensive sectors may be presenting such an opportunity for investors. Since the end of the so called "taper tantrum" from May and June 2013 (was it really a reaction at the time to the fact that the Fed might potentially raise interest rates at some point in the future, or was it more a reaction to the immediate issue at the time that the People's Bank of China was clamping down on aggressive lending activity in its shadow banking system by withholding much needed liquidity from their domestic financial system? All signs indicate it was the latter and not the former, but I digress), defensive stocks both in the U.S. and outside of the U.S. had moved in complete lockstep with one another. And this took place even with the periods of currency volatility that took place along the way. But in recent months, U.S. and non-U.S. defensive sectors have diverged widely from one another. And this may be presenting an opportunity for U.S. investors to discover attractive defensive positioning in non-U.S. markets.

The first example is U.S. and non-U.S. consumer staples (NYSEARCA:IPS), which moved in lockstep until late August when the two began to completely diverge.

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The same can be said of U.S. and non-U.S. health care (NYSEARCA:IRY), which traveled in unison until the beginning of July when a sudden break took place.

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Utilities have joined this experience more recently. After holding together through the end of September, U.S. and non-U.S. utilities (NYSEARCA:IPU) have completely split from one another


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But can't all of these performance differentials be explained at least in part by the sudden strong strengthening of the U.S. dollar (NYSEARCA:UUP) since the beginning of July? Yes, the rising U.S. dollar has played its part. But this has been an extraordinarily strong move in a relatively short period of time. And it has been built on the premise that the U.S. Federal Reserve will actually follow through and not only raise interest rates but keep them raised sometime in the next year while other major global central banks remain intent on continuing to debauch their own currencies beyond all recognition. Yen (NYSEARCA:FXY) anyone? And will ECB President Mario Draghi actually find the way to implement even a sliver of all of those stimulative policy promises for the euro (NYSEARCA:FXE) that he's been repeatedly teasing over the last several years?

But even if all of these U.S. dollar policy themes actually come to fruition in the coming months, the currency is still approaching a key resistance level that has turned it back lower twice in the post crisis past. The U.S. dollar index is currently at 87.74, which is above the 2012 and 2013 peaks but still just below the spring 2010 that marked its current stock bull market highs. As a result, the dollar may struggle to break out above the 89.11 reading that marked the March 2009 high.

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What is perhaps even more notable from a U.S. dollar perspective is that the last time the U.S. dollar was this strong was just after the end of QE1 when everyone was preparing for the Fed to raise rates in the coming months. Knowing what we know now, the notion that the Fed might raise rates in 2010 is almost comical, for it was this same Fed that was throwing itself into QE2 only a few months later as all of the problems in Europe came bubbling to the surface. And the fact that the U.S. dollar index was so subdued on a day when the latest Fed minutes struck a hawkish tone suggests that further near-term upside in the dollar index may be constrained and that risks may be building to the downside going forward.

For all of these reasons, the negative currency effects from a strengthening U.S. dollar on any non-U.S. defensive stock positions may not be as pronounced as it has been over the last few months. And the potential does exists for notoriously unpredictable currency markets to send the U.S. dollar back lower, which would put the wind at the back of any potential non-U.S. defensive sector names.

But with that being said, any potential non-U.S. security under consideration should be considered in the context of potential local currency price volatility relative to the U.S. dollar tied to the stock going forward.

Lastly, for those investors considering non-U.S. defensive stock exposure, they may wish to explore the international sector ETFs mentioned above. Or they may wish to establish such exposure through individual stock securities from non-U.S. companies that trade as American Depository Receipts (ADR) on the U.S. exchanges. Representative names include Anheuser-Busch (NYSE:BUD), British American Tobacco (NYSEMKT:BTI) and Diageo (NYSE:DEO) on the consumer staples side; Novartis (NYSE:NVS), Sanofi-Aventis (NYSE:SNY), AstraZeneca (NYSE:AZN) and Novo Nordisk (NYSE:NVO) from the health care sector; and National Grid (NYSE:NGG) among utilities.

Bottom Line

While owning defensive stocks may not protect investors from a broader downside move in the stock market, they may help mute the price decline and provide a more consistent returns experience. And the opportunity to gather defensive names outside of the U.S. may be particularly interesting to investors at present given the wide performance divergence we have seen between U.S. and non-U.S. defensive stocks in recent months.

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