Market volatility scared investors into high-quality, defensive asset classes and exchange traded funds in 2011. As investors fork over a premium for the added safety, some defensive plays have become quite expensive.
Last year, defensive plays like utilities, consumer staples, healthcare and telecoms, were strong performers, but utilities are looking rather expensive relative to their historical averages, Russ Koesterich, iShares Global Chief Investment Strategist, says in a research note. [Utilities Fall as Investors Embrace Riskier Sectors]
Utilities usually trade at a discount to the market multiple, but they were at a 7% premium at the end of December.
Koesterich notes that changes to Bush tax cuts have caused the discount in U.S. utilities to shrink from 30% to 10%. If the tax cuts should expire in 2013, investors may see prices reverse.
Investors seeking to stay with a defensive focus during a volatile market may want to steer clear of utilities and go with consumer staples, healthcare and telecom sectors, instead, Koesterich advises.
- SPDR Utilities Select Sector Fund ETF (NYSEArca: XLU): down 3.1% year-to-date
- SPDR Consumer Staples Select Sector Fund ETF (NYSEArca: XLP): down 0.7% year-to-date
- SPDR Health Care Select Sector Fund ETF (NYSEArca: XLV): up 2.8% year-to-date
- SPDR S&P Telecom ETF (NYSEArca: XTL): up 3.9% year-to-date
When looking for quality, investors consider size, beta and dividends. With these considerations in mind, mega-cap assets may still hold value, Koesterich said.
Furthermore, U.S. mega-caps are still trading at a historically high discount compared to other areas. For instance, the S&P 500 is trading at 12-times trailing earnings compared to 14-times in the Russell 3000, or a discount of around 15%, which is above the long-term average of 9%. On a global scale, mega-caps are trading at 11x earnings compared to the 13x in the MSCI World Index.
- Vanguard Mega Cap 300 ETF (NYSEArca: MGC): up 3.0% year-to-date
Vanguard Mega Cap 300 ETF
For more information on sector plays, visit our sector ETFs category.
Max Chen contributed to this article.