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Why Do the Defensive Sectors Appear More Expensive?

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Dividend stocks, particularly those in more defensive industries, are and have been expensive for some time. This is a function of several trends: a preference for safe, stable companies, the growing popularity of minimum volatility funds and the quest for yield. The last one here should come as no surprise given central banks have anchored short-term interest rates at zero and long-term rates continue to be suppressed by massive asset-purchase programs and the generally sluggish nature of the global recovery.

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Market Realist – Defensive sectors appear more expensive than cyclical ones

The graph above compares dividend yields across the ten sectors of the S&P 500. Dividend yield indicates how much a company pays out in dividends each year relative to its share price. As you can see, defensives such as utilities (IDU) and consumer staples (XLP) have higher dividend yields. Conversely, cyclical sectors such as the technology (QQQ)(IYW) and consumer discretionary (XLY) sectors have lower dividend yields.

The defensive sectors appear more expensive than they have been in the past, as well as more expensive than cyclical sectors. The slowing global growth has caused investors to flee to defensive sectors, which tend to be less volatile due to the steady nature of their earnings. Also, lower bond yields have increased the popularity of defensive stocks, which have doled out higher dividends historically.

Some defensive sectors, such as utilities and staples, are often referred to as “bond-proxies” because of their sensitivity to interest rates. Lower interest rates have boosted these sectors to an extent.

Meanwhile, minimum volatility funds (USMV), which invest mostly in low-beta or defensive stocks, are growing in popularity. This is mainly because they have given better risk-adjusted returns historically.

All of these factors have caused expansion throughout the defensive sectors.

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