Bill O’Neill, portfolio strategist at Merrill Lynch Global Wealth Management, warns investors not to rush out to buy those stocks which are more resilient in a downturn.
 
Much is being said about how so called ‘defensives’ – stocks which are more resilient in a downturn – have been left behind in the market rally and are now cheap. Well, yes, but only up to a point. In reality such stocks look good value because others have marched ahead. This is distorting valuations and flagging up opportunities that may not materialise. 
 
In current markets, investing on the basis of relative valuations is brave. The valuation of cyclical sectors is based on expectations of earnings recovering from an extremely low base. Once earnings of these companies have rebounded, they will look better value and the defensive sectors sectors no way as cheap, relatively speaking.

If cyclical company earnings undershoot, however, these valuations will be shown to be highly misleading and investors will suffer. It’s like judging a golfer’s skill based on watching one shot on the driving range. There’s too little to go on.
 
If the market continues to make progress over the summer, as we expect, defensives will look even cheaper compared to the market. Investors should wait for the rally to die out before reaching for defensives.