This has been a good year for the stock market thus far with gains of over 10 percent. What has been somewhat unusual, is that the gains have been concentrated in the more conservative areas of the market.
Normally the more defensive stocks do better when the stock market is performing poorly.
The more defensive areas of the market are generally considered to be Consumer Staples, Health Care and Utilities.
This is because spending in these areas is not impacted too much by changes in the economy.
For example people will continue to eat irrespective of the economy, but a business will not purchase new equipment during difficult times.
Until 2013 in recent years when the stock market was doing well it was typically cyclical companies that were the market leaders, such as Industrials.
That is because when the economy is improving the more cyclically oriented companies see a faster increase in earnings relative to more defensive ones.
What has happened this year is that the global economy has softened somewhat, while the U.S. has remained reasonably stable.
China’s growth rate is starting to slow, while Europe remains in a recession. Overseas profits have become increasingly important for many companies, so investors have focused more on the global economy versus the U.S..
The reason the stock market has done well is that, in spite of a slowing global economy, the perception of risk has declined.
For example even though European economies are performing poorly, there is a belief that there will not be a financial collapse. That is why government bond yields in countries, such as Italy and Spain have declined this year.
In our environment of very low interest rates investors are increasingly looking for alternatives to low yielding bonds.
The alternative has increasingly become higher dividend yielding stocks, which tend to be concentrated in the more defensive industries.
Many companies have dividend yields around 3 percent, while their bonds with maturities around 7 to 10 years are yielding closer to 2 percent.
A bond is a fixed payment, while a stock dividend isn’t, so a stock still has more risk. However, many food and drug companies have not cut their dividends during difficult times, and have in fact raised them consistently every year for decades.
Because the defensive stocks have done very well this year, they are now more expensive relative to more economically sensitive companies.
As long as interest rates stay at very low levels, stocks with higher dividend yields should perform reasonably well.
Technology and Industrial companies will perform better, if the global economy starts to improve.
Most likely the economy worldwide will not change significantly for the balance of the year.
However, on a longer-term basis the more economically sensitive companies look more attractive, albeit with somewhat greater risk relative to defensive corporations.
For those invested in diversified funds, such as an S&P 500 index product, you will have a combination of defensive and economically sensitive stocks.
If you own individual stocks, or a sector fund you should be aware whether those holdings are defensive or economically sensitive.
The stock market has been hitting new highs recently, despite a fairly sluggish economy.
However, in a low interest rate environment with rising dividends stocks continue to look relatively more attractive to bonds. As long as we continue to avoid a new global recession, the stock market should continue to perform reasonably well.
