It may be time to go on the defensive
Feb 1 2010 by Christine Hawdon, The Journal
IF 2009 was the time to "dash for trash" only time will tell what the theme for 2010 will be. Following the low point in the stock market in March 2009, investors who positioned their portfolios towards cyclical sectors were handsomely rewarded.
Cyclical sectors, such as mining and technology, tend to be the first to benefit from any recovery in global economic conditions.
In the FTSE 350 Index, the strongest performing sector last year was industrial metals and mining, which climbed by an astronomical 307%. The FTSE 350 Index ended the year 24.5% higher. Other sectors to benefit included technology, up by 131%, and industrial engineering, which increased by 83%. To put this into perspective, share prices in these areas had plummeted during 2008 and early 2009. Valuations of many cyclical companies are now looking over-stretched and expensive. Equity markets have climbed far higher than many expected, so a bout of profit- taking is due.
Therefore, if stock markets have got ahead of themselves and there is a pause for breath then investors may seek returns other than capital growth from their investments, for example through dividend payments.
Over the last few weeks, a number of well respected fund managers have reported they are taking profits from cyclical companies which have had a strong run and are looking to park their funds in defensive sectors.
Defensive sectors usually include companies which may be regarded as dull and dependable but which have a reliable cash flow. A strong cash flow generally means that a company can support or even grow its dividend and at a time when bank deposit rates are paltry, a healthy dividend may appear attractive even if the share price does not significantly outperform.
Defensive shareholdings are normally found in the utility, pharmaceutical and tobacco sectors as well as consumer sectors such as beverages and food producers. Such companies may have strong global brands and a bias towards overseas earnings may also be appealing if the recovery is sluggish here in the UK.
The multi-utility sector was in the bottom five of the worst performing sectors in 2009. However, they got off to a great start in 2010 thanks to the cold snap which had us all reaching to turn up the thermostat. Prices of utilities are usually index-linked which means that companies have the potential to protect themselves against inflation. Dividend yields in this sector are typically quite high.
Pharmaceutical companies could also prove interesting. They generally have strong balance sheets backed by reliable cash flows. Both GlaxoSmithKline and AstraZeneca have been rationalising and cutting costs. Diversification of the business could also play a part. For example, distribution relationships with generic manufacturers may help increase exposure to the fast growing emerging markets where sales are gaining momentum.
Tobacco, beverages and food companies also tend to have strong cash flows as when recession bites, as people often seek comfort in smaller treats such as fags, booze and chocolate. The UK and European markets are choked by ever-increasing duty taxes, regulation on advertising and a healthier lifestyle craze, but growth is still improving strongly elsewhere in the world.
In conclusion, while interest rates remain low, companies which can pay a reliable income stream from healthy cash reserves may appear favourable and the share price of well-run UK companies which missed out in the 2009 rally could surprise on the upside this year.
Share
