Getting Defensive

May 2, 2022No Comments

Hello, and welcome to Smart Money Dumb Money. And I am your host, Keith Richards, I’m president and chief portfolio manager of ValueTrend Wealth Management. And today we’re going to talk about investing in the safe parts or the safe sectors of the markets. We’re going to talk about defensive sectors. Now I’m going to address these sectors specifically because of my macro alerts that I am hoping many of you who watch this blog have seen me post on my blog over the past month. Back in early April, I put out a high-risk alert on the blog based on the readings I was getting from my Bear-o-meter compilation. And if you don’t know what that is, you can go back to the blogs and type in under the search engine Bear-o-meter, bear O meter, and you will see explanations on how I put that compilation together, but basically that compilation is a mixture of momentum, of trend, of sentiment and market breadth.

And I put all these factors together. Plus there actually is a valuation factor in there, a fundamental valuation factor. All of those factors I put together, I assign a weighting and then we read the relative risk versus the relative reward potential on the markets at any given moment. So during extreme moments of high risk and relatively low return potential, we obviously want to be cautious. During periods of extremely good opportunity with relatively low risk, we want to be in stocks and we want to be looking for good ideas and backing up the truck and buying equities. Most of the time, the Bear-o-meter hovers in the middle somewhere. Obviously most of the time the market is pretty good, but there’s nothing either overly risky and overly exciting to the upside either. Things are normal. So we want to pay attention when the Bear-o-meter gives extreme readings and on April 7th, we got a high risk.


We got literally a zero out of eight reward versus risk potential. It was a very, very high risk alert. And so at ValueTrend, we acted on that alert. And what did we do? We started raising cash. And in the blog, if you read that blog, I suggested that investors might start looking at their own portfolios and maybe considering taking some risk out of their portfolios, given the potential risk versus reward on the markets. Now, remember there’s always risk and there’s always reward potential on the stock market. So something like my Bear-o-meter is not something that you go all out or all in on. Because even when there’s a high reward potential, say the Bear-o-meter gets an eight out of eight, which means a very, very high reward on a relative basis, it doesn’t mean there’s no risk and vice versa. When it got the zero on April 7th doesn’t mean there was no potential for it going up.


It’s just, it’s a relative reading. And typically when I see these extremes near zero or near eight, I’m going to take some action. And so the action we took was raise cash. We raised about, at that time, around 16% cash in our equity models, which is our regular equity model and our aggressive model. And today is the 27th of April and we just raised another chunk and we’re over 20% cash as I speak. Why are we 20% cash now? Well, one of the things we’re paying attention to, and I noted this on a blog just a few days ago, and I called that blog “The Potential of a Bear Market Is Increasing.” That was more or less the title of the blog, trying to recall what I actually called the blog, but it was based on my outlook for the potential for an outright bear market, not just a correction has been increasing.


Now notice, I didn’t say it’s a bear market. I didn’t say that. I said there is a potential of a bear market and that potential is increasing. So the main factor I’m paying attention to is 4200 on the S&P 500. And I’m also paying attention to leadership. And we’re going to talk a little bit about leadership today, but when it comes to the leadership factor, one of the big thorns in the market’s side right now is the fact that the former leaders which I have been warning you about for months and months and months now on this blog, I’ve been telling you that the NASDAQ stocks, the NASDAQ in particular, and the FAANG (Facebook, Apple, Amazon, Netflix, Google) are in a high risk situation.


And this is not a new thing. So it is of no surprise to me or anybody who follows my work that the NASDAQ has been getting crushed. And the FAANGs have been getting crushed along with the NASDAQ. So when those market leaders, and this is what happens at the beginning of every bear market, it’s one of the things that concerns me is that at the beginning of every bear market, you will see a rotation from the leadership group that has been in place for months and months, if not years. And that’s exactly what’s happened folks. So that’s one of the factors. The other thing is, is that you look for a series of higher highs and higher lows for bull market and lower highs and lower lows for a bear market. And we’ve got most of those conditions in place, including the fact that the S&P has been floating below its 200-day moving average for quite some period of time, look on a chart and you’ll see this.


I noted on my last blog, the bear market potential blog, that if 4200 in the S&P 500 is broken, you have every condition in place for a bear market. Now, when I say broken, I don’t mean one day, and then it goes back up. I mean, a successive period of days. My bare minimum for that is three days. Okay. And that’s the bare minimum. I will usually wait at least a week or two before I really proclaim a bear market, but it’s April 27th today. On the 26th, which was Tuesday, the 26th of April, the S&P at the end of the day, definitively broke through 4200. Now, as I record this, the market is up, but you probably will be watching this video a few days from now. So I can’t tell you if that 4200 break, which happened on the 26th is the real McCoy.


It might have just been a spike below 4,200 and the market goes back up. And if so, I will maintain that between 4200 support and 4600 resistance is going to be the period, going to be the levels of consolidation if we are in a period of a consolidating market. So right now, all I can tell you is that the market looks more risky than it does look for a lot of upside. I’m not calling a bear market yet, but perhaps a week from now, I will. So I just have to play it by ear at this point. In the meantime, I want to make note that if you feel the way I do that, the odds are that we’re going to be at best in a sideways consolidated position on the markets for the coming months or possibly worse, which is an outright break of the 4200 level in a bear market.


If you feel that’s a good potential of happening, then you might want to consider raising cash and you might want to consider holding utilities and healthcare and staples, and that kind of an investment including real estate, by the way, as part of your portfolio. Why? Because these sectors are typically what we call defensive sectors. Now, I want to mention something that these are defensive sectors and if you look at what the market does, when it’s worried, markets like to go into something. Markets don’t like to hold cash for too long. So especially in a low interest rate environment, and yes, rates are going up, it’s all relative. Rates will still be low even when they raise the rates, you know, 50 beeps and then a hundred beeps and on, you’re still in a very, very low rate environment.


So markets are going to want to get some kind of return and the dividends on some of these stocks, particularly the utility sector and the REITs and the real estate sector, can be very attractive to people. Seasonally, those sectors can be very good over of the summer. In fact, there’s kind of a strategy that people like Brooke Thackray and Don Vialoux and Yale Hirsch originally, and Jeff Hersh, his son, these guys have always said, look, you rotate out of things like the technology NASDAQ type of stocks, and you go into these defensive sectors over the summer. Well, that’s a seasonal thing. The only thing that’s against this prognosis of having some defensive stocks in your portfolio right now is the fact that interest rates are not kind to these sectors, not so much healthcare, but certainly the other three sectors. Particularly, let’s talk about utilities for a second because they have very high capital costs, very high debt and very little potential for earnings growth.

So if rates go up, they have the same amount of debt as always. And the profitability goes down because they don’t suddenly sell, you know, 4 million new you know, people’s houses using their product. It’s usually a fairly steady growth and steady income kind of model that the utilities run. So they tend to get hurt more than other stocks and the same goes for real estate and even staples to a large extent. So I want to look at the four sectors and I’m just going look at it from a pure technical point of view. What are the charts telling us about these sectors? So let’s share screen and get on with the show. So I’m bringing you right to the consumer staple section, which has been the real leader. Now, we’re looking at XLP, which is the SPDR ETF in the US, for the US staples, and disclosure ValueTrend, we hold a pretty healthy chunk of this, and it’s helped us outperform for the past quarter or so.


So you can see that it’s been in a nice, steady trend. It is a little overbought. You can see that the distance over the 200 days is a bit much. I would expect it would pull back. But given that we’re entering into the seasonality period, given that we’re entering into a high-risk environment, I would think that if the market pulls anywhere near the 50-day moving average, which is about $76 or $77 on this ETF even 78, I think it would be a pretty good time to add to positions. And it’s probably a good safe sector to hold over the summer. So definitely that has been one of the outperformers. Take a look at this chart and then take a look at the chart of the S&P 500.

And you can, there has been clear rotation into this staples and out of all of the growth orientated stuff. Okay. So now let’s look at real estate. Now this again is the US real estate ETF, the SPDR ETF XLRE. We don’t hold this. You can see it’s been consolidating. Consolidating is not so bad when the market’s going down. In fact, it kind of went up during the period of the S&P falling, and it’s kind of leveled off. It might pull back a bit again, you know It’s in some sort of a consolidation pattern here with the floor somewhere in the low forties and a ceiling somewhere around the mid forties to 50 bucks, but whatever the case sideways plus a dividend isn’t a bad thing. Now, we’re going to take a look in a minute at the Canadian real estate sector, just because the US sectors have got a little bit more industrial exposure.


And I will point out that industrial exposure and residential exposure is one of the risks with holding this sector right now, because yes investors are looking for a place to hide, these pay a high dividend. But if the economy slows down then the properties, if we go into a recession, the properties that these people hold and often the cash flow that can come out of these properties from their industrial tenant says their business clients see a slow down in their business, the cash flow can decrease. So you have got to keep that in mind. If we go into a recession, and there’s a very real potential of that happening, then you don’t want to continue holding real estate or REITs, but for the time being the sector looks okay, just keep that in your cranial vault, because nothing lasts forever. So just be here for a good time, not a long time, as I think it was Triumph sold that saying that. I don’t know if it was actually Triumph, but anyways. So the utility sector, we don’t own this either, but the SPDR utility sector as well has had a very big return while the SP is sold of. Again, it’s that rotation out of the high beta sectors into utilities.

Now you can see it’s pulling back and it needed to because that’s a parabolic move, and that’s not something that you normally see on a defensive sector like utilities. I mean, as I mentioned, the cash flow on utilities is pretty straightforward. They have a certain amount of growth every year that they can bank on. And really it’s not a growth area. So the fact that it went parabolic, it was acting almost like Tesla, and that’s not a good thing. So I would very much expect the utilities to pull back in the near term, but it’s still been an outperformer when the market’s been selling off. So it’s something we should pay attention to. And as all of these charts, I’m showing you, they have positive seasonality behind them. I just probably wouldn’t jump on the utilities today. I’d wait for a bit more pullback.

All right, the healthcare sector. Now, this sector does to me look like a little bit of a consolidation. You can see the highs are getting higher but the lows are pretty flat. So again, that’s been an outperformance of the S&P 500, but not as much so as some of the other sectors, particularly consumer staples that we’ve been looking at. So to me now that we’re bouncing on the 200-day, it could break below that red line, which is the 200-day moving average, but probably the health care sector will be okay this summer and flat. And sometimes flat, particularly if you can pick a stock with a high dividend in the sector, can be a good thing. So keep an eye on this. It’s showing signs of probably hitting a point where it might find support, but I’d give it another week or so.


So again, it’s known as a defensive sector to begin with, and it’s known as a good sector to hold over the summer. So you should have this on your radar. Finally, the Canadian REITs. So we looked at the US REITs, the Canadian REITs have a more diversified platform. You know, there are many stocks in here that have industrial and small commercial rental places, but there’s also some actual residential stuff. Now, residential REITs may be affected as well by recession. So keep in mind, people lose their jobs, they don’t pay their rent. So just there’s no free lunch here, but what I’m kind of interested to see is that it is consolidating in a relatively flat pattern. It doesn’t look like it’s breaking down. So any sign of upside from here, if the Canadian REITs start to bounce from here, you might see it move back up to the top of that trading range which seems to be somewhere between around low $19 area to high $20 area.


So it’s pretty flat, not huge profits to be made, but the dividend is pretty high on REITs and you can pick and choose amongst the index for individual names, or just look at the index itself. But again, a defensive sector, not a lot of growth, but hey, if you can earn a little bit of dividends and maybe see it swing to the top of this range, not a bad thing. So that’s it. We’ll end it here. I’ve talked a lot about defensive stuff. And again, I really want you to pay attention to the S&P 500 in the next little while because that 4,200 area, which I’ve talked about twice now in my blogs, is pretty vital to be held. I did suggest when the S&P was just coming off of the 4,600 high at the beginning of this month, that the market looked scary. I still feel that there’s a lot of risk potential, but again, to repeat myself, I’m not calling this a bear until the market actually starts to decline past 4,200. Thanks for watching. Hope that was helpful. We’ll see you again next week.


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