Buying defensives that make cash and hand money back to shareholders via buybacks and dividends is a popular strategy at the moment, as macro headwinds keep the bulls at bay.
Analysts at Morgan Stanley have been asking if this strategy has run its course, their conclusion, no.
“The factors behind our more defensive stance have not changed and the key catalysts we’ve identified to turn more positive are not yet in place” said Graham Secker, the UK equity Strategist at Morgan Stanley in London said in a research note.
“We would be surprised if we had already reached the end of this period of defensive rotation given that outperformance of the defensive group is still modest so far and that non-commodity cyclical sectors are trading close to relative highs”
Given this stance, Secker is advising investors to look at reliable growth stocks and those paying a high and secure dividend yield.
The stocks that tick both those boxes in Secker’s view are AstraZeneca , BAT, H&M, Imperial Tobacco and Sanofi-Aventis. Buying drug makers and tobacco stocks is something we have heard again and again at CNBC in recent months and Morgan Stanley believes four factors continue to back this view.
These are the macro news flow which is likely in Secker’s view to weigh on risk appetite until the end of June, defensives being cheap and under-owned, seasonal factors that will boost defensives in Q2 and Q3 and low growth expectations of defensives relative to cyclicals.
Growth in Europe is under pressure according to Secker who has been worried by a big fall in the European PMI index, a weak business survey from Belgium (traditionally seen as good lead indicator for the entire euro zone) and Morgan Stanley’s ‘Surprise Gap Index’ turning negative. The index measures current production versus expectations 3 months ago of said growth.
The end of QE2 has been seen as many as the key catalyst for re-evaluating investment strategy over the coming months, but Secker believes lower growth will be the more important event.
“The end of QE2 – we are firm believers that the economic growth outlook is a more significant determinant of equity direction than liquidity factors, but given current macro uncertainties we believe investors will be averse to re-risking ahead of the end of June when QE2 is due to expire”
“If economic news flow has stabilized by then, we’d expect the ending of the QE2 program to have a minimal impact on stocks; however, if the growth outlook is continuing to weaken at that time equities could see a more significant drop,” said Secker.
Morgan Stanley seeks to and does business with the companies mentioned in this report and may or may not hold any of the stocks discussed.