Normally, an attempt to link lightbulbs, banks and diapers would be a setup for a bad joke. But on Wall Street, the three share a common trait: They belong to sectors that have snoozed through the greatest bull rally in years.
The year is half over, and even with the most recent pullback, the markets up for the year. Shares of the country's biggest companies enjoyed their best start to the year in more than a decade and energy stocks soared. But you wouldn't have experienced any of this exuberant flush if you had invested in the stocks of utilities, financial firms, or companies that make and sell consumer staples -- stuff like toothpaste, aspirin, detergent and diapers. These stocks missed their wake-up call. So did many shares of financial firms, consumer staples, and utilities. These sectors aren't just short-term laggards, either; all have underperformed the market for the past 12 months.
To be sure, defensive sectors such as consumer staples and utilities typically lag so-called cyclical stocks (retail, industrial and equipment makers, to name a few) during most phases of a bull market. And with the market having about doubled since March 2009, this rally has been bullish in every sense of the word. (Defensive stocks, as the name implies, traditionally do better in market retreats, as investors take comfort in the constant demand for these companies' products.) But why haven't financial stocks -- which typically lead the way when the economy begins to expand -- followed the script? This time around, says David Bianco, chief U.S. equity strategist at Bank of America Merrill Lynch, they've been weighed down by a host of domestic factors, including low loan demand and a depressed real estate market. Banks, says Bianco, are more dependent on homegrown demand than are, say, oil or industrial firms.
Financial stocks aren't the only group that's veered from the typical recovery playbook. Energy, industrial and material stocks tend to peak later in a normal recovery, but this time around, they're posting record-high profits earlier than usual, Bianco says. Helped by a weak dollar, American firms are supplying customers around the world, and this demand has helped offset the more modest appetite at home for products such as cranes, computers and cars, experts say.
What does this all mean for investors looking to play the recovery? The pros seem divided on energy, with some, like Bianco, saying the sector has less room for improvement and others arguing the stocks still have room to surge. As for the lagging sectors, the advice is to be selective. Not many experts, for instance, see opportunity in utility stocks now. Yes, these companies pay steady dividends, but much like bonds, utility stock prices are sensitive to rising interest rates. And interest rates, say veteran watchers, are almost sure to rise sometime within the next year or so. (When rates go up, utilities' dividends become less attractive to investors.) Consumer-staple companies, on the other hand, look attractive to many pros. Wal-Mart, for example, appears cheap, trading at just 13 times this year's expected earnings, well below its 10-year average of 22, says Jason Clark, portfolio manager at Al Frank Asset Management, which owns the stock. Wal-Mart outperformed in the worst of the downturn, when it benefited from even affluent shoppers' turning to its stores. But analysts say the retailer lost its way when it began changing its merchandise mix to suit these so-called trade-down consumers. Now "they're trying to call back their core consumer," Clark says. He also likes the international growth prospects for the company, which gets about one-quarter of its sales from abroad. While staples look solid, financial stocks are a "wild card," Bianco says. They could become leaders later this year if oil prices don't escalate further and interest rates don't spike.
Indeed, many analysts say much of the recovery hinges on those two factors: energy prices and interest rates. If oil hits $120 a barrel and stays there, the economy might stall or slip, analysts say. "If people are spending money on $4 gas, they're not spending it on anything else," says James Angel, associate professor of Georgetown University's McDonough School of Business. Sharply rising interest rates would also dampen the economy by curtailing the availability of credit and further depressing real estate. The Fed is not likely to raise short-term interest rates -- currently at all-time lows -- too much while unemployment remains high, yet traders will likely start pushing long-term rates higher in anticipation of future Fed action, economists say. What's more, investors are watching to see what will happen this summer when the Fed begins to end its $600 billion stimulus known as QE2 -- its second round of "quantitative easing" -- which was designed to spur the economy. But as long as neither oil nor interest rates go parabolic, things look okay. The current bull market is in its third year. "We could have another year or two left," says Brian Jacobsen, chief portfolio strategist for Wells Fargo Advantage Funds, which hold $230 billion. And if not? Well, at least those staple stocks you bought on the cheap may begin to rouse from their sleep.