By Wallace Witkowski, MarketWatch
SAN FRANCISCO (MarketWatch) -- Dividend-rich defensive stocks
have lost their luster as Treasury yields have jumped, leaving
cyclical sectors like banks and tech to do the bull market's heavy
lifting.
With 10-year Treasury yields rising to their highest level in
more than a year from last summer's historical lows, it should come
as no surprise that stocks which benefitted from a search for yield
bonds are now tanking.
The past week was tough for equities in general with the Dow
Jones Industrial Average (DJI) down 1.2%, the S&P 500 Index
(SPX) falling 1.1%, and the Nasdaq Composite Index (RIXF) slipping
0.1% for the holiday-shortened period. All three benchmarks,
however, finished up for the month of May, with the Dow industrials
up 1.9%, the S&P 500 up 2.1%, and most notably, the tech-heavy
Nasdaq rising 3.8%.
Earlier in the year, tech was the least-loved sector as
investors chased stocks with traditionally high dividends.
Now it's those sectors with steep payouts, the so-called
defensive plays including utilities and telecom, that are the dogs
of the market. The telecom sector averages a 5.3% dividend yield
and the utilities sector averages a 3.9% dividend yield. In May,
the utilities sector dropped 9.6%, the telecom sector dropped 7.4%,
and consumer staples fell 2.4%.
By comparison, financials, industrials, and tech -- the best
performing sectors in May -- have average dividend yields of 2%,
1.8%, and 1.5%, respectively. For the month, financials rose 5.9%,
industrials gained 4.6%, and tech rose 4.2%.
For much of the year utilities have also had a higher 12-month
trailing price-to-earnings ratio than tech stocks, as noted by
Bespoke Investment Group. But that's finally changed with the P/E
ratio for utilities falling to about 15.9 and tech rising to 16.2,
according to Bespoke.
No-dividend did better than high-dividend in May
Stocks with a dividend of 4% or more that fell 10% or more
during May in the S&P 500 included FirstEnergy Corp.(FE) , Duke
Energy Corp.(DUK) , Consolidated Edison Inc.(ED) , and Verizon
Communications Inc. (VZ). No one stock in the S&P 500 with more
than a 4% gain had a rise of 10% or more.
On the other hand, many more stocks offering no dividend gained
more than 10% in May such as Advanced Micro Devices Inc.(AMD) ,
Micron Technology Inc.(MU) , Goodyear Tire & Rubber Co.(GT) ,
Electronic Arts Inc.(EA) , and Priceline.com Inc.(PCLN).
Fed focus, Treasury yield jump started in May
The turning point appears to have been at the beginning of May
when the Federal Reserve's policy statement said the central bank
was prepared to increase or reduce the pace of its bond purchases.
Investor focus tended to focus more on the tapering part of the
statement and that thinking got a big boost later in the month when
Fed Chairman Ben Bernanke told Congress a scaling back of bond
purchases could happen over the next few months.
Over the month of May, the yield on the 10-year note (10_YEAR)
jumped 46 basis points to end the month at 2.13%, and had been as
high as 2.23% on Wednesday. It was the biggest yield-rise, and the
worst month for Treasurys, since December 2010.
In fact, on Wednesday, the yield on the 10-year Treasury note
rose to intersect with the steadily declining dividend yield for
the S&P 500, matching for the first time this year.
Still, that doesn't necessarily mean those yields will stay
high. Birinyi Associates said Friday that 10-year yields have
jumped by more than 50 basis points on five other occasions since
March 2009 and none of those led to sustained higher yields.
Even before the Fed released its latest policy statement, many
analysts have been beating the drum for a shift into cyclical
stocks, most notably Goldman Sachs. Though there are plenty of
doubters: HSBC strategists said last week that too many factors are
arrayed against these sectors -- perhaps barring tech -- such as
too much spare capacity in the commodity sector.
Focus on economic data more key going into June
In mid-April, it appeared evident that economic conditions would
not likely roll into a summer swoon, so more investors positioned
themselves behind relatively cheap cyclical stocks and started
taking profits on defensives, said Mark Luschini, chief investment
strategist at Janney Montgomery Scott.
"You could get a relapse if you have a setback in terms of
economic news," Luschini said. "Short of that, I don't think
[defensives] will outperform cyclicals."
On Friday, consumer sentiment reached its highest level since
2007, and the Chicago purchasing managers index jumped higher than
expected. Even a drop in April consumer spending was not considered
that bad for the economy when much of that decline could be linked
to lower energy prices.
The coming week marks a heavy one for economic data with ISM
manufacturing and services data along with May job numbers.
Watching economic data will be a "tangled situation," Luschini
said. On the one hand, good economic data supports earnings growth,
which is the backbone for stock valuations. On the other hand, good
economic data could also give knee-jerk investors an excuse to sell
because it means a tapering of easing measures is that much
closer.
The strategist thinks the big data point will be the May jobs
number. If it's above 180,000, that'll put us on track for 6.5%
unemployment sooner rather than later, at which point the Fed will
start hiking interest rates, he said. Analysts polled by
MarketWatch expect the addition of 168,000 jobs.
Defensives are, like, so Q1 2013
Whatever happens to the broader market, however, most analysts
agree that the play for safe stocks has pretty much run its
course.
The rush to low volatility stocks has created a bubble, which
may be on its way to deflating, said Savita Subramanian, equity and
quant strategist at Bank of America Merrill Lynch, in a recent
note.
Prices on low beta appear stretched, the use of leverage to
amplify returns, and the proliferation of low volatility ETFs all
point to a bubble, she said.
"Valuations and recent performance suggest we may be at the
beginnings of the low beta unwind," Subramanian wrote. "Like other
bubbles, we fear this will end badly."
In the rush to safety, investors appear to have equated low
volatility with high-quality stocks. Using S&P quality
rankings, Subramanian shows that while industrials may be the third
most volatile sector in S&P 500, they also have the highest
percentage of high-quality stocks with stable earnings records. On
the other hand, the telecom sector, which is the second least
volatile sector, has the fewest percentage of high- quality
stocks.
"Investors that equate low beta with earnings stability may be
surprised to find that sectors that are penalized for being too
cyclical, and thus trade at higher betas, have actually exhibited
far more earnings stability over the last cycle than some of their
lower beta counterparts." Subramanian said.
Likely, cyclicals will continue to rally relative to defensives
until they become overbought, according to Andrew Garthwaite at
Credit Suisse in a recent note.
Cyclical stocks, which move in the same direction as bond yields
about 80% of the time, have about 5.5% higher to go before they are
considered overbought, Garthwaite said.
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