The
S&P 500
is almost at record levels, but it isn’t too late to ride the rally. Sectors that have failed to keep pace with the market offer an opportunity to buy in.
The index is up about 23% for the year, putting it some 1.6% below its record closing high. That includes a 1.3% pop on Wednesday, when the Federal Reserve indicated it may have finished raising interest rates and may cut them in 2024.
That gave the market confidence that the economy can keep growing despite the 11 boosts to rates the Fed has rolled out since March 2022. It was great news for stocks that are sensitive to changes in demand for goods and services.
It is also positive for high-growth technology names because lower rates increase the discounted current value of future profits. Growth companies are valued on the basis that they will produce the bulk of their profits years from now.
All of these stocks, though, aren’t necessarily the ones to chase at this point. Industrials on the S&P 500 hit new record highs this week and the index’s tech sector is already up more than 50% for the year. These stocks have become more expensive, and they face heightened risk if earnings don’t meet expectations.
Companies that haven’t kept pace look more appealing.
“We should expect the laggard sectors of the market (real-estate investment trusts, staples…utilities)… to outperform,” wrote Sevens Report’s Tom Essaye.
Those sectors have traded poorly this year. Investors have been pouring money into stocks that are more likely to gain if a healthier economy boosts demand for goods and services.
But this week, the laggards have perked up—a shift Barron’s has anticipated for the past few months. Investors are starting to rebalance their portfolios by adding these names.
There is plenty to like about industries such as utilities, which people buy more for their dividends, and less for growth. While the
Utilities Select Sector SPDR Fund
outperformed the S&P 500 on Wednesday, rising almost 4%, it remains down just over 7% this year.
That points to room for more gains if yields on 10-year Treasury debt keep falling from this year’s high of near 5%. Lower rates on fixed-income securities make dividends more attractive.
The fund’s dividend yield is 3.4%. That’s still a bit below the 10- year Treasury note’s 3.9% yield, so if the 10-year yield keeps falling, the dividend yield will look more appealing. That’s especially true because utilities tend to increase their dividend payments every year, while interest payments from government bonds are fixed.
Earnings are expected to keep growing because utility providers are building new renewable-energy plants. The states they operate in allow them to maintain a certain return on those growing assets.
“There is some mean reversion in defensives as [bond] yields decline,” wrote 22V Research’s Dennis DeBusschere, referring to sectors such as utilities, consumer staples, and real estate investment trusts.
The Charles Schwab US REIT Exchange-Traded Fund is in the green for the year, but underperforming the S&P 500 by double digits. It jumped just under 4% Wednesday, when the news from the Fed caused bond yields to fall.
Its dividend yield is 3.8%. Earnings have grown every year since 2020 according to FactSet. Rents have risen, allowing dividend payments to increase every year since then.
The Vanguard Consumer Staples Index Fund, meanwhile, is down about 1% this year, but popped 1.9% on Wednesday. Its dividend yield is 2.6%, while payments have grown every year since at least 2016. Analysts expect more dividend increases next year, helped by 7% growth in earnings. Sales are estimated to increase in the low single digits, helping nudge profit margins higher.
It all adds up. Defensive stocks are the sweet spot in the current rally.
Write to Jacob Sonenshine at [email protected]
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