Are Defensive Sectors Too Expensive to Be Valuable Right Now?
The markets have officially come off the post-election high and are now looking uncertain in the face of a far more aggressive rate hike from the Fed. Investors might be looking for some kind of safe haven asset class in order to weather a possible upcoming storm and classic defensive sectors like utilities, healthcare and consumer staples are the first places to find shelter. But with markets overheated, true defensive value could lie elsewhere.
Dividend yields might be attractive for investors who are looking for downside protection, but it’s hardly a secret. That means that dividend payers are in high demand, driving up valuation multiples and essentially robbing them of their defensive powers. When everyone is after the same thing, the price goes up and value goes down.
Looking for Value in All the Wrong Places
One of the most common mistakes beginning investors make is assuming that defensive stocks automatically mean less risk and greater wealth preservation. But true value lies in a stocks price to earnings multiple. This is how much of a premium investors place on a company’s future streams of income.
Right now, the average P/E of the S&P 500 is over 26 – 26.14 to be exact. Considering that the average mean is only 15.65, that means that, in general, stocks are historically overvalued. While P/E has climbed much higher before collapsing in the past, the fact the stocks are trading above their historical averages should send a red flag to investors.
Once the market becomes saturated and investors have no more buying power to put into already overheated stocks, the markets can quickly find themselves in a downward correction spiral. Normally, bear market jitters send investors to traditional defense sectors, but even these parts of the stock market appear to be overvalued.
Stocks in sectors like utilities, known for dividend yields, low growth and low risk, are trading well above their P/E averages right now. The average P/E in this sector is at 22.5 times earnings. But other typically defensive sectors aren’t faring any better. Coca Cola, a $183 billion consumer staples conglomerate, is trading at nearly 29 times earnings. Despite the 3.5 percent dividend yield, the premium on this stock doesn’t seem to outweigh the lack of value.
Just because equities are overvalued, doesn’t mean there aren’t other investment opportunities. Bonds are usually chosen for their defensive capabilities, but in the face of higher interest rates, it’s a tough market to invest in at this point. Instead, investors might want to broaden their horizons to commodities like gold and silver. These safe haven assets can help hedge against inflation, while holding value independently of stock and bond performance.
Regardless of what happens to stocks or bonds, precious metals hold their value much better. In fact, most commodities tend to outperform when stocks and bonds go down. For investors who are looking for a truly defensive sector, commodities – particularly gold and silver – look like a much better deal.