Playing Offense With Defensive Sectors 

The stock market sent investors a crystal-clear message last week, and it wasn’t one to be taken lightly.

Against the current chaos of a market landscape that is crushing every questionable growth company in its tracks, along with every pseudo-macro secular trend that pretends to be havoc-proof, it should be noted that all get-out-of-jail free cards have expired. The S&P 500 broke technical support, and it now is every stock for itself.

It sounds bad on the surface, but not so bad if you know how to rotate your capital to what the market favors. And there are always sectors and stocks that provide safe haven returns when market turmoil is elevated. This is one of those times to not try and be clever, as there is little room for stocks exposed to anything other than those sectors that the market trusts.

This past week’s hawkish Fed rhetoric was anything but reassuring. There was no admission by the Federal Reserve that it flubbed when the short end of the yield curve spiked to levels not seen since 1981, while the broader yield curve inverted and fueled talk of a hard landing in the second half of this year.

The war in Ukraine, lockdowns in China, soaring inflation, supply chain constraints and the absolute dereliction of leadership in Washington is at the heart of why the market is having a confidence problem. The idea that the market got religion because Fed Chairman Jerome Powell telegraphed a 50-basis-point increase at the upcoming May 4 Federal Open Market Committee (FOMC) meeting is laughable.

Everyone in the global world of bond trading already knew full well that a half-point hike was a done deal. What took on a dragon-sized narrative of its own was the notion of a 75-basis-point hike followed by further in-kind hikes in June and July to catch up with inflation. That’s what sent the three-, five- and seven-year Treasury yields to 3%. And if anyone tells you otherwise, they’re lying. 

The latest FedWatch Tool forecast has 99.6% probability of a half-point hike coming, but investors should not be surprised if a three-quarter-point increase occurs due to how the bond market is trading. While the Fed votes once a month, the bond market votes every day, and it sees inflation staying well above 5% and bond yields adjusting higher as a result. 

So, what’s on the other side of this equation? Very simply, stay with what is already working. The major averages have been punished this past week to where the selling pressure even got into the knickers of the most favored sectors — namely energy, consumer staples, utilities, real estate investment trusts (REITs), agribusiness and health care. A rolling correction gathers no moss, or stocks that avoid price disruption.

When the market finally takes down the most favored sectors for a few percentage points, then the broader sell-off is likely hitting a climax or point of exhaustion. That does not mean it is time to pivot back into the stocks and sectors that got the most hammered in the downdraft. My experience is that a wash-out of the kind just witnessed provides an attractive entry point for buying into the energy, staples, utilities, REITs, agribusiness and health care stocks on a material pullback.

Forget for a minute what’s happening in the stock market. Look at the damage inflicted in the investment-grade corporate bond market. And this doesn’t take into account the hundreds of leveraged closed-end funds and bond mutual funds. Rate shock is hitting bond assets everywhere, triggering wholesale portfolio changes.

It was reported this past week on CNBC that there is roughly $55 trillion invested in the U.S. bond market, where $5 trillion has already been vanquished in the past two weeks alone. Imagine when investors get their April brokerage statements showing another 10% hit to their bond holdings principal. That money will likely fly out of the bond market and right into the very sectors noted above for defensive safety and yield. 

Because the mega-cap tech stocks make up over 28% of the S&P 500 and 50% of the Nasdaq, investors shouldn’t be surprised to see the grim headlines regarding the market’s daily performance. That’s the world we now live in, and there is no way around it. What does matter is that there are at least five stealth bull markets underway within the broad market that offer excellent total return prospects. 

Trying to time peak inflation and the end of quantitative tightening (QT) as to when the market will embrace its heavily weighted index components is very uncertain. All the current forecasts are based on fluid data, meaning they don’t matter. What matters is where sovereign, endowment, pension and institutional money flows are heading, so retail investors can go where the tides are still coming in. 

The hot sectors are finally consolidating. Don’t be clever or cute or try to outsmart the market. Just be in the places that the market wants to own. It is not that hard if you follow the big money.

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