Santoli: Grandma's portfolio may be overvalued

Published Thu, Mar 24 201612:25 PM EDTUpdated Thu, Mar 24 201612:51 PM EDT

Is it possible to pay too much for top quality? Can the ability to sleep at night be overvalued? Investors should be asking these questions as they try to navigate a market that continues to reward the anointed "quality" stocks — those stable blue chip names that now look almost as expensive as they are popular and boring. Sure, the ripping 12 percent rally from the panicky Feb. 11 market depths was initially animated by a surge in the riskiest, most-hated stocks, inflicting maximum suffering on overeager short sellers and believers in the global recession scenario. Yet the strength in dicier, more jumpy stocks did not really come at the expense of those "defensive" large-cap stalwarts in the consumer staples, telecom and utilities sectors, which are still handily beating the broad market year to date. Participation in the equities seven years after the start of the bull market remains grudging and shadowed by macroeconomic worry, and so investors have a strong preference for perceived safety and decent dividend yields — stocks that act somewhat like corporate bonds, in other words. Read More What would a Trump presidency do to markets? Renaissance Macro Advisors called the current rebound the "highest quality rally in 20 years" in terms of the relative strength of these stocks with sturdy fundamentals, good balance sheets and healthy dividend payouts. A more focused gauge of this trend is the Powershares S & P 500 Low Volatility ETF (SPLV) , a portfolio of the 100 stocks in the S & P 500 that have displayed the greatest stability relative to the general market. This fund has outperformed the S & P 500 by 7 percentage points over the past year and by 4 so far in 2016. The ETF is just a whisper from its all-time high. It is even slightly ahead of the S & P over the past five years, with that advantage built up since the broad market peaked last spring. Source: FactSet This action resembles the leadership of conservative big-cap stocks coming out of the nasty 2011 sell-off, when the low-volatility ETF surged 22 percent in less than six months into March 2012, and dusted the broad market by a wide margin. It seemed that investors were willing to take only so much equity risk exiting the frightening European debt crisis and U.S. debt-ceiling standoff. This S & P Low Volatility ETF is jammed with big food companies such as Campbell Soup , which keeps hitting new highs even as Wall Street sighs with ennui toward the somnolent soup canner. Waste Management , another stock that has gone up steeply despite scant core business growth, is in there, too. This is grandma's portfolio, winning bragging rights over the aggressive-growth approach of the adrenaline-seeking investor. The low-volatility basket has trounced its racier mirror-image ETF, Powershares S & P High Beta ( SPHB ) by a gaping 22 percentage points in the past year. This fund, capturing the most mercurial stocks in the benchmark, is freighted with plenty of commodity companies, some whippy semiconductor stocks and asset management firms tethered to the fortunes of the market itself. The public has voted its preference: It's "peace of mind" in a landslide over "need for speed." The low volatility ETF has almost exactly 100 times as much in assets under management as the high-beta counterpart ($6.4 billion to $63 million). That's largely because there is a logical motivation for seeking out calmer stocks while there is little natural demand for owning the jumpiest ones as a group. And, of course, all powerful trends are based in a plausible idea. In this case, stocks that produce yield and aren't tightly linked to the short-term economic cycle have greater value in a low-growth world that is scarce of safe-yielding assets. Such stocks are increasingly being used the way "widow-and-orphan" stocks were in the 1950s, as stores of wealth with dividend streams that could outpace inflation, rather than performance vehicles built for hasty appreciation — even though they have been appreciating quite briskly of late. Read More Top investor Martin Sass putting cash to work Wall Street finds wisdom in playing defense in this manner. JPMorgan strategists like U.S. multinationals as an attractive risk-reward bargain, while Bank of America Merrill Lynch strategist Michael Hartnett recently counseled selling into this rally and owning "defensive growth" stocks such as the staples sector. But at what price does this stop making great sense? The defensive groups look least attractive on most valuation measures. And while valuation has never proved a great, timely stock-picking tool in this sector, it increasingly seems investors in this area should try to become satisfied with the dividend stream alone rather than bank on much upside. Consider that in aggregate the S & P Low Volatility portfolio trades at more than 19 times the companies' 2015 earnings, up from a multiple of 16 in 2012. The S & P High Beta ETF is at 14.3 times 2015 profits, roughly the same as where it traded four years ago. The low volume fund yields 2.15 percent versus 1.6 percent for the high beta version. Of course, the portfolio of more stable companies will more reliably hit its modest earnings targets, while profits remain on the decline for the riskier components of the high beta fund. This is less a call to own volatile stocks with messy fundamentals and more a prompt to be mindful of overpaying for the crowd favorites among the big, household-name stocks. One way to combine the selling points of both approaches is to get exposure to big industrial stocks. They have many of the virtues of other solid multinationals — healthy margins, and a sector dividend yield of 2.1 percent — with a valuation more in line with the broad market. Chart watchers have begun to get behind the sector as it began outperforming just as the "industrial recession" theme got overripe in the winter. These stocks won't shelter investors from the global economic winds. But in this environment they could be preferable to buying an overpriced cushion against routine market turbulence.

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Is it possible to pay too much for top quality? Can the ability to sleep at night be overvalued?

Investors should be asking these questions as they try to navigate a market that continues to reward the anointed "quality" stocks — those stable blue chip names that now look almost as expensive as they are popular and boring.

Sure, the ripping 12 percent rally from the panicky Feb. 11 market depths was initially animated by a surge in the riskiest, most-hated stocks, inflicting maximum suffering on overeager short sellers and believers in the global recession scenario.

Yet the strength in dicier, more jumpy stocks did not really come at the expense of those "defensive" large-cap stalwarts in the consumer staples, telecom and utilities sectors, which are still handily beating the broad market year to date.

Participation in the equities seven years after the start of the bull market remains grudging and shadowed by macroeconomic worry, and so investors have a strong preference for perceived safety and decent dividend yields — stocks that act somewhat like corporate bonds, in other words.