* Cyclical stocks look expensive after rally
* Defensive sectors attract ETF money-Markit
* Healthcare among top earnings season performers
By Tricia Wright
LONDON, Feb 22 European equity markets are
starting to plateau and investors keen to milk further gains are
switching into stocks better suited to a low growth environment.
Citigroup's keenly-watched U.S. Economic Surprise Indicator
(CESI) has turned negative, a historical harbinger for
outperformance of so-called defensive sectors such as healthcare
and food and beverages, which are traditionally more reliable in
terms of earnings and dividends.
The rally of around 24 percent seen in European equities
over the eight months to a January peak, bolstered by the
European Central Bank's promise to defend the euro, has left
stocks that are highly geared to the economic cycle expensive.
The real estate and retail sectors, for example, are trading
on 12-month forward price/earnings ratios of 18 times and 14
times respectively, compared with the market average of 12
times, according to Thomson Reuters data.
Meanwhile, deteriorating confidence in euro zone growth,
political worries surrounding Spain and Italy and fears the U.S.
Federal Reserve could prematurely wind down its asset purchase
programme have seen stock markets drift back in past weeks.
Normally this might cause a rotation out of stocks
altogether. But in a climate of low interest rates and
below-inflation bond yields, equities retain the edge over other
asset classes. So investors are turning to defensive stocks.
"We think that one should be looking over the next
two-to-three months for consolidation in the markets ... (and
for them) to have less of the cyclical weight and more of the
defensive weight," JPMorgan analyst Mislav Matejka said.
JPMorgan recently moved its rating for cyclicals to
"underweight" versus defensives, highlighting that during market
pauses, pharmaceuticals and consumer staples tend to shine.
Its research shows that a move below zero on the CESI
has, on the last five occasions, seen
underperformance of European cyclicals against defensives during
the following three months - by 4 percent on average.
Investors have started to shift that way this month, despite
the already relatively expensive valuations.
Europe-focused exchange-traded funds covering defensive
sectors saw net inflows of $39.2 million from Feb. 1-17, having
suffered outflows in January, with the biggest boost coming from
healthcare tracking products, according to data firm Markit.
Cyclical sectors, over the same period, saw net outflows of
$186 million after attracting money in January.
"Before the economic situation starts to improve clearly in
Europe, it will take time for the cyclicals to really do much
better," Fabrice Theveneau, head of equity research at Societe
Societe Generale is keen on pharmaceuticals, anticipating a
modest rebound buoyed in part by their strong emerging market
True to form, at around half time in the European earnings
season, defensives are among the top performers, led by
In a sign this earnings superiority will continue, European
healthcare and consumer staples sectors sit on implied 10-year
EPS compound annual growth rates of 3.8 and 6.3, heralding
better prospects of increased earnings against the STOXX Europe
600 on 2.4, Thomson Reuters data showed.
Citi European equity strategist Jonathan Stubbs described
'defensive growth', or firms with proven track records in times
of broad economic and profit distress and which are growing
faster than the market, as an "earnings call option".
A call option profile has 'limited' risk of falls but
'unlimited' potential for gains, and so defensive growth fits
Stubbs said that in 2008/2009, when market earnings halved
from peak to trough, those for defensive growth firms fell less
than 20 percent.
Citi is "overweight" healthcare, in which Sanofi,
Bayer and Novartis are key picks, and food
& beverages stocks, among which it likes Anheuser-Busch InBev
"To chase cyclicals we'd need to believe in a strong pick-up
in domestic or global growth - which we don't. Modest growth is
unlikely to be the launch-pad for sustained cyclical
outperformance in 2013," Stubbs said.