“The first quarter took most investors by surprise on the strength and breadth of the equities market,” Jim Russell, the senior equity strategist at U.S. Bank Wealth Management, which manages about $110 billion, said in an April 1 phone interview. Russell, who said pensions and other funds owned too few shares in November, says he’s selling U.S. equities now and buying bonds. “We expect a pullback before too much longer.”
While American stocks have been in a bull market for four years, defined as an advance unbroken by a decline of 20% of more, stocks have frequently retreated. The rally has lasted for 49 months and 16 of them have generated losses.
Shares in the benchmark gauge for American equities slipped 3.3% from April to June last year, 0.4% in 2011 and 12% in 2010, three of the five quarterly losses since equities bottomed in March 2009. Industries with earnings least reliant on expanding gross domestic product generated the best returns each time as technology companies and banks fell.
Investors have fewer choices now after defensive industries, normally what fund managers buy when they are concerned about growth, are trading at a 26% valuation premium to the rest of the market. Johnson & Johnson, the largest seller of health-care products, has rallied 17% this year, the third-best gain in the Dow Jones Industrial Average. Alcoa has the second-worst decrease, falling 5.1%.
“We’re being very cautious,” Chad Morganlander, a Florham Park, New Jersey-based fund manager at Stifel Nicolaus & Co., said in an April 5 Bloomberg Television interview. His firm oversees about $130 billion of assets. “You’re not seeing the self-sustaining lift that we need to have the market go from 1,550 to 1,750.”
Morganlander, who predicted in December that stocks would increase this year, said he’s raised the level of cash in his funds to 18% and is buying bonds.
The U.S. economy will expand at a 1.9% rate this year, down from 2.2% in 2012, according to the median estimate of 83 economists in a survey by Bloomberg. The forecast for a 1.8% earnings contraction in the three months ended in March compares with a prediction for a 1.2% gain at the start of the year.
Higher price-earnings ratios for defensive stocks are no reason for the rally to fizzle, according to John Stoltzfus, chief equity strategist at Oppenheimer & Co. Rather, they may reflect individuals returning to the equity market for the first time since 2007 who want to keep their investments conservative.
“If you’re coming back to the market, if you’re layering in and building a portfolio, you start to come in with consumer staples, health care,” he said in an April 3 interview on Bloomberg Television’s “Surveillance” with Tom Keene, Sara Eisen and Nela Richardson. “You have a real improvement in fundamentals, and that’s driving stocks higher.” He predicts the S&P 500 will climb to 1,585 by the end of the year.
Valuations for defensive shares are higher than any time since the bull market began. Makers of consumer staples in the S&P 500 trade at 18.1 times annual profit after gaining 14% in 2013, led by Avon Products Inc., which has a multiple of 31.