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NEWS - A Taste For Defensives Sours Prospects For European Stocks

A Taste For Defensives Sours Prospects For European Stocks

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Defensive stocks such as healthcare companies, which often bring up the rear when markets rise, have led the gainers in 2013 as European bourses hit their highest in years, suggesting investors don't think the good times will roll for long.

Defensive stocks such as healthcare companies, which often bring up the rear when markets rise, have led the gainers in 2013 as European bourses hit their highest in years, suggesting investors don't think the good times will roll for long.

These stocks, which typically generate reliable earnings and dividends as demand for their services tends to be stable, have been popular this year given pessimism over global growth and the lower profit expectations for companies whose fortunes rise and fall with the economic cycle.

With few other investments generating such attractive yields in an era when bonds are returning less than inflation, healthcare stocks are drawing interest even though they are at their most expensive in more than five years.

"People will continue to search for yield, will continue to search for safety, are prepared to pay up for that, and (defensive stocks) will get ever more expensive," said Andrew Cole, a fund manager at Baring Asset Management, which has 39.4 billion pounds ($60.5 billion) of assets under management.

The STOXX 600 European Healthcare index is trading at 14.7 times expected earnings over the next 12 months, a level not seen since January 2008 and above its 10-year average of 14.1 times, Thomson Reuters DataStream shows.

Yet fund managers increased their holdings in defensive stocks in April, led by pharmaceutical companies, a BofA Merrill Lynch survey showed. Mining companies, classic cyclical stocks, saw some of the biggest declines.

Simon Maughan, head of research at Olivetree Financial Group, said a return to the seven-year average price/earnings ratio for healthcare relative to the STOXX Europe 600 could see the sector outperform the index by a further 10 percent.

Citi recently reiterated its "overweight" rating on healthcare, with Novartis, Sanofi and Bayer its preferred big European Union companies in the sector.

Healthcare along with food and beverages, another defensive sector, have been among the top performers in 2013, as the broad FTSEurofirst 300 of top European shares has advanced some 8 percent, supported by central bank stimulus.

Drugmaker AstraZeneca and grocer Wm Morrison are among FTSEurofirst stocks that have risen least in rallies and fallen least in declines over the past three years, but they are up around 14 percent and 10 percent, respectively, this year.

The stock performance is in line with fundamentals. Consumer staples, utilities, telecoms and healthcare - all defensive sectors - have beaten expectations by the biggest margins in the current quarterly earnings season.

Earnings on average for the four respective sectors have outpaced forecasts by 7.2 percent, 5.6 percent, 1.4 percent, and 0.4 percent, according to Thomson Reuters StarMine.

"People aren't buying stocks because they are getting more bullish; people are buying stocks because there is little alternative," said Emmanuel Cau, strategist at JPMorgan.

"Within the equity market they are still positioning quite defensively, so for us it is very difficult to see how we can move out of the current atypical regime."

Economic trends point to such outperformance continuing. The keenly watched Citi Economic Surprise Index (CESI), which captures how well U.S. economic data is matching expectations, has dipped back into negative territory, which in the past has heralded a shift into defensive sectors.

JPMorgan research shows that since CESI moved below zero at the end of January, cyclicals have lagged defensives.

Europe-focused exchange-traded funds covering defensive sectors have seen net inflows of $6.51 million from May 1-10, according to data from Markit. Cyclicals over the period saw net outflows of $20.05 million.

"People are not seeing good signs in terms of economic growth so ... will continue to play within the defensives," said Fabrice Theveneau, head of equity research at Societe Generale.

Reliable profits and dividends is even drawing bid interest for some defensives; British water company Severn Trent said on Tuesday it had received a takeover approach that sent its shares up as much as 19 percent and gave other UK water utility shares a speculative boost.


 

 

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