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2006-08-29 :: Defensive Stocks

There is a lot of interest in defensive stocks right now.  I have a problem getting excited about them as their earnings and valuations are so mismatched.  Their earnings just don’t support their valuations, which are in typically higher than average and their earnings are less than average.

The chart above shows you a 5-year comparison of Apache Oil and Johnson & Johnson.  Apache falls within the group of cyclical stocks closely tied to economic growth; Johnson & Johnson is a defensive stock that you are supposed to own to protect against an economic downturn.

The growth of Apache over five years exceeds 200%; the growth of Johnson & Johnson over the same five years is 25%.  When constructing a diversifed portfolio, including the defensive stocks can lead to significant underperformance of portfolio returns.  Every few years, the defensive stocks will outperform the cyclicals for a few months.  In anticipation of the last recession (5 years ago) they outperformed for a period of nine months, then languished for five years, barely keeping ahead of inflation.

We are adding some defensive names, with stop losses set, to get us to the next stage of the cyclical bull market.  The defensive names will be our source of funds to reposition client portfolios at that time.  The long-term name of the game is investing with the economy, and ultimately the cyclicals will be the winners.

More later!

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