The recent selloff in the U.S. stock market and U.S. Treasuries has brought a shift in the performance relationships that investors have become used to in recent years.
Yield suddenly has become unpopular, leading to a gravitation away from both bonds and “bond proxies.” The weakness in these bond proxies, in turn, has pressured the market segments usually thought of as being defensive — and put an unlikely sector in the position of leadership.
Since the market peaked on May 21, the usually defensive utilities and telecommunication services have been the two worst sector performers, and the previously stalwart consumer staples sector has lagged slightly.
While the consensus view initially was that the cash leaving these sectors would flow into cyclicals, renewed concerns about global growth have prevented that from happening. In fact, energy, materials, and industrials have all lagged the S&P 500 by a small margin since the May 21 inflection point.
So if cyclicals and defensives are both lagging, what areas are generating positive relative performance? The answer is a sector that used to be high-beta, but that now — at least in the large-cap space — is showing defensive characteristics: technology.
During the recent period of market weakness, techs have outperformed and emerged as the “least bad” sector:
|Sector ETF||Ticker||Return, 5/21/13 – 6/5/13|
|Consumer Staples SPDR||XLP||-3.71%|
|Health Care SPDR||XLV||-3.90%|
|Consumer Discretionary SPDR||XLY||-4.16%|
|Telecommunications Sector Index Fund||IYZ||-6.11%|
|SPDR S&P 500 ETF||SPY||-3.53%|
In fact, a look at the sector’s top 10 largest stocks — which excludes Visa (V) and MasterCard (MA) even though both are typically placed in the “technology” category — shows that eight mega-cap techs have outperformed the S&P 500 during the downturn, while four have finished with positive returns.
|Stock||Ticker||Return, 5/21/13 – 6/5/13|
|International Business Machines||IBM||-2.83%|
|Average||-1.54% (vs. -3.53% for SPY)|
It’s somewhat surprising that tech stocks are outperforming right now, since concerns about economic growth should be a headwind for this group — at least in theory. But one reason that hasn’t been the case is that the cash flowing out of traditional defensives needs somewhere to go … and what better destination than the large, cash-rich, familiar names in technology?
Just as important is the fact that large-cap tech stocks aren’t saddled with valuations that are well above historical levels — something that can’t be said for traditional defensives. According to Standard & Poor’s, the telecommunications, consumer staples, and utilities sectors of the S&P 500 Index were trading at price-to-earnings ratios of 19.8, 17.8, and 15.9 on 2013 estimates heading into the downturn — all of which represented a premium to the 14.9 P/E of the S&P 500 Index.
Technology, in contrast, was trading at a discount: 13.7.
Sure, large-cap techs aren’t knocking the cover off the ball in terms of their earnings potential. S&P estimates that the tech stocks in the S&P 500 will generate growth of 3.2% in 2013 — less than half of the 6.7% anticipated for the broader market. Still, this is enough for the sector to compare favorably on a P/E-to-growth (PEG) ratio of just 1.1. This is lower than the 1.4 of the broader market and well below the 3.8 commanded by utilities, 2.5 by telecom and 1.8 by consumer staples.
Looked at from this perspective, it makes perfect sense that tech would outperform in the current downturn. The large-cap names in the group weren’t caught up in the bond-proxy trade of the past half-year, but they nonetheless offer many of the characteristics investors would look for among defensive names that could be expected to ride out a downturn.
For a group of stocks to be considered truly defensive, however, they need to exhibit down-market outperformance for more than a few weeks. If the market remains wobbly through the summer, watch tech carefully to see how well it withstands a period of protracted volatility.
This may provide the clue of whether big techs — and funds such as XLK — are becoming more of a safe haven than they have been in the past.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securit