Charles Schwab on the need for defensive utilities

4 Jul 2012 | News - Comment now

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Charles Schwab on the need for defensive utilities

Kully Samra, of US financial services firm Charles Schwab, explains why investors should be looking at the utilities sector as concerns over the US economic outlook grow.

Tactical investing at the sector level can become more challenging as markets trend back toward a "risk on-risk off" type of action, as appears to currently be the case. As we've noted previously, macroeconomic factors—especially in the form of European news and developments—appear to be dominating investor attention. In such an environment, markets can trade within a range as they wait for the next macro catalyst, which can then move markets violently up or down depending on the event.

Tactical investing for these potential "fat tail" scenarios can be difficult. How can investors place odds on European politicians finally coming to an agreement to stabilize their debt crisis, versus the chance that the European Union breaks apart? Or that US politicians will come to an agreement to avoid the "fiscal cliff" scheduled at the end of the year?

We suggest that it's impossible to accurately predict the outcome of what are seemingly such irrational situations at times. Therefore, we are maintaining a largely neutral stance with a bit of a barbell approach that allows a portfolio to potentially benefit from a sudden rally, while also providing a bit of defense against a downturn. And we must note that we are leaning slightly toward the defensive side of the ledger as we are growing more concerned over the status of global growth. 

Attempting to achieve this balance, we recently upgraded the defensive utilities sector to marketperform from underperform. As confidence in the economic expansion in the US grew, we saw the utilities group be the leading underperformer to start the year. However, as concerns have increased, we've seen the performance of the group rebound recently. The higher-yielding, domestic oriented sector has attracted investor interest and we believe may continue to be attractive in this uncertain environment.

Conversely, we moved the more globally and cyclically exposed industrials sector down to underperform from marketperform. Growth appears to be slowing around the world, and while central banks appear to be reacting, their effectiveness is at least somewhat in question and we believe corporate spending will remain cautious and government expenditures continue to be constrained.

Despite the downgrade, we continue to believe (as a result of tight purse strings in corporate offices during past years) companies are at the point where they appear to need to start replacing and updating equipment—potentially eventually benefitting the industrials sector. But growing uncertainty appears to be resulting on tighter wallets for the time being.  

We are maintaining our outperform rating on the technology sector. Recently, we've seen a bit of underperformance as we believe investors have taken some profits and digested the robust gains seen since October of last year, but we also view this as a healthy and relatively short-term phenomenon.  Therefore, we continue to like the increasing dividend payments and solid balance sheets of the group, while also appreciating the growth prospects that still exist as companies attempt to increase efficiency and productivity.

We believe these actions leave us with a relatively balanced approach that is appropriate for this environment but also recognize that the situation could change quickly and we are ready to move further as developments occur.

In addition to the above ratings, we continue to hold a marketperform rating on the consumer discretionary, consumer stables, energy, financials, healthcare, materials, and telecom sectors. Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors, so check back often.

 

Kully Samra is UK branch director at financial services firm Charles Schwab
 

Related topics: US equities Charles schwab, Kully samra, Utilities

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