Markets & Finance

Playing Defense


By Joseph Lisanti After last year's rush to buy stocks that had been left for dead in the bear market, some money is now rotating into issues that were relatively flat in 2003's advance. Many of these are considered defensive stocks. Does that imply the market is poised to tumble?

The Nasdaq Composite Index, the poster child for bubble-era excesses of the late 1990s, gained 50% last year. But this year, the Nasdaq has trailed the S&P 500 and the Dow Jones Industrial Average, both of which contain fewer "new economy" stocks. Also trailing in 2004 are some sectors of the S&P 500 that had surged last year.

Meanwhile, sectors like consumer staples (household products, soft drinks, etc.) and health care (managed care, pharmaceuticals, etc.) have risen sharply in recent weeks after lagging in 2003. Stocks in these industries are often larger-capitalization, higher-quality dividend payers. Historically, in the second year of an upward move, investors have favored such stocks over those considered more speculative.

Yet this rotation into defensive stocks does come at a time when consumers are feeling less confident about the economy. We attribute the nervousness to a still-weak job market and higher energy prices. Cold weather has kept oil prices high this winter, and the threat of OPEC cutbacks has consumers worried. But OPEC has always been better at announcing production cutbacks than enforcing them. As for jobs, we still expect improvement, albeit slow, in the months ahead as the economy continues to gain strength.

The rise of higher-quality stocks appears to be nothing more than the typical market action at this point in the cycle. But consumer attitudes can't be ignored. S&P still projects growth in the domestic economy in the months ahead. Nevertheless, if consumers believe that growth has slowed, it can become a self-fulfilling prophecy.

So far, there is little evidence of a consumer pullback. Consequently, we still advise keeping most investment assets in equities. Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook


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