Comment: I’m not ready to move out of defensives

This is how it went: ultra-low interest rates across the world are going to be with us for most of this year – if not longer. Go overweight in US trusts and funds – the economy is going gangbusters. This is not the time to be under-invested in the world’s most tech-driven and innovative market.

Steer well clear of mainland Europe and especially the eurozone. Renewed crisis in Greece and a triumph for the radical Left would put the single currency region in peril. And the eurozone economy is barely showing any growth as it is. Steer clear!

Meanwhile, keep faith with the UK. The economic recovery is broadly intact. Lighten up on those defensive, utility stocks and go for companies set to benefit from the continuing cyclical upturn. Look at what has changed since then. So strong is the US labour market now that Margaret Yellen, chairwoman of the Federal Reserve, has dropped loud hints that a US rate rise may be nearer than most are counting on. Indeed, the dollar is now gaining strength in expectation of a rate rise. That makes life more difficult for big US exporters and will crimp earnings growth. And, as most oil and commodity prices are quoted in dollars, the weakness of the pound against the dollar pushes up their prices in sterling terms, which pushes up the input costs for UK companies.

The eurozone? The European Central Bank has finally launched its own version of QE. The single currency has tumbled. Suddenly prospects for eurozone exporters are looking much brighter. And so, are prospects for the troubled “Club Med” economies of Greece, Spain, Italy and Portugal as tourists flock to take advantage of the cheaper euro and lower holiday prices.

And the UK? The weak euro is no comfort for UK companies exporting into the eurozone. While exports to the US should benefit from the weaker dollar against the pound, these only account for some 15 per cent of our export total. By contrast, exports to the eurozone are some three times this share.

Meanwhile, the skies are clouding as the election approaches. It brings the prospect of a gridlocked parliament and the emergence of a Miliband premiership backed on a confidence and supply basis by a greatly enhanced SNP. The more likely this prospect, the more investors will be likely to take their bets off the table.

Now it’s true that the January optimism was followed by a sweep in the FTSE 100 index to an all-time high. However, seldom has a rally been plagued by more doubts. And last week the index fell back by almost 3 per cent. Against this background the argument continues to rage as to whether investors should be holding on to “defensive” shares – broadly speaking utility companies such as electricity, water, gas and telecoms, together with pharmaceutical stocks, food retailers and defence shares. But now that an upturn is well underway, we should be moving into “cyclicals” – companies where profits are driven by the economic cycle.

This has long been a big divide in investment thinking. But what do these terms really mean now? Do shares really fit so comfortably into these pigeon holes?

Last week Money Week investment writer Bengt Saelensminde took BlackRock’s chief investment manager Russ Koesterich to task for this categorisation when he argued we should now be getting to into cyclical investment. He made reference to the rotation under way in the US, where investors have been piling into consumer cyclical exchange traded funds.

But in the new world of ultra-low interest rates and ever greater government interference the division isn’t quite as black and white as it used to be. Is the food retailing sector such a blanket defensive zone, resistant to changes elsewhere in the economy?

In truth, it’s deeply divided, between Tesco’s terrors and dividend-axing Morrisons at one end and the discounters such as Aldi and Lidl gaining market share on the other.

What about the overall picture? According to Morningstar, over the last three years the best performing sector has been healthcare, with a 27 per cent return – a classic defensive sector. But coming in second was consumer cyclical, with a return of just under 20 per cent. Technology was a close third with a 19 per cent return (cyclical), and consumer defensive came in fourth with 16 per cent (clearly defensive!). Where’s the pattern in all that? And should we really ditch defensives? Like the Money Week writer, I’m happy to stick with those dull, dividend-paying defensives for now.

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