CWS Market Review – March 19, 2024

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Why You’re Not Diversified When You Think You Are

One of the themes I stress to investors, especially newer investors, is the importance of owning a diversified portfolio. So often, I’ll hear investors say, “sure I’m diversified! I own AMD and TSM.” Well, that’s not exactly proper diversification. Owning two stocks that closely mimic each other does little to lower your risk.

Diversification is an important topic and it’s more difficult than it may appear. By not being properly diversified, investors can leave themselves exposed to risks they’re unaware of.

For example, an investor may load up on several stocks that are highly sensitive to the U.S. dollar. When adding those stocks, they may have had no idea that that was the case. Then, after a few days of trading, they see how their portfolio can be impacted by, say, the decisions of a foreign central bank. They had no idea that’s what they were getting themselves into.

I’ve also seen many investors become overly exposed to technology stocks. This leaves them open to the twists and turns of the capital investment cycle of some large companies they don’t own.

I even fell prey to this effect last year when I had both Danaher and Thermo Fisher Scientific on our Buy List. I like both stocks, and it’s no wonder because the companies are similar. Not surprisingly, both stocks tend to behave very similarly, especially in the short term. I should have realized this beforehand.

An investor can own Lowe’s and Home Depot. There’s certainly no law against it, but understand the position and risks you’re taking. To quote Winston Churchill, “Money is like manure, it’s only good if you spread it around.”

Oftentimes, you’ll see an investor who had a particularly strong year but on closer inspection, they were merely overly exposed to a particular risk that paid off. Was the investor brilliant or did some category like small-cap growth have a banner year? Humphrey B. Neill said, “Don’t confuse brains with a bull market.”

Our Buy List is a good example of the portfolio that’s well diversified. You don’t need to own every stock, but a healthy sample can start you on your way to owning a high-quality portfolio that’s properly diversified.

The Worst Environment for Defensive Stocks in Decades

I highlight this point because right now, we’re seeing this effect play out. In particular, I’m referring to the lagging performance of many defensive stocks. Sectors like Consumer Staples and Utilities are at their worst relative performance levels in decades.

Check out this chart below:

The chart shows the S&P 500 Consumer Staples divided by the S&P 500 (in black) and the S&P 500 Utilities divided by the S&P 500 (in red). If those lines are rising, then they’re beating the market, but if they’re falling then they’re lagging the market.

Right now, the lines are as low as they’ve been in at least 25 years. These lines are important to watch because it reflects how popular defensive stocks are, and right now, they’re very unpopular.

What’s going on? Defensive stocks, as the name implies, generally move opposite to the overall economy. When the economy gets weak, investors want to own safe and secure defensive stocks. But when the economy is strong, or is perceived to be strong, then investors shy away from defensive stocks in search of cyclical stocks.

It’s not that one group is in any sense better than another. Rather, time and chance happens to them all. You’ll notice that both lines got a little bump four years ago at the start of Covid. Again, I need to stress that this is relative performance. Both sectors were falling severely, just not as severely as everyone else was.

Defensive stocks tend to do well when interest rates are falling, which also tends to align with a weak economy. Defensive stocks did indeed trail the market as the Federal Reserve hiked interest rates.

Lately, there appears to be a disconnect between defensive stocks and the state of the economy. The economy certainly has its strong points, but I’m still surprised by how poorly defensive stocks have been behaving. I always pay attention when good stocks have underperformed for some time. I wouldn’t be surprised to see the cyclical/defensive cycle soon turn.

On our Buy List, Hershey (HSY) is a good example of a defensive stock that’s been hurting. See the chart below which shows the relative performance of Hershey, meaning HSY divided by the S&P 500.

That’s quite a run-up followed by a rundown. During an economic downturn, folks don’t cut back on their purchases of Hershey Kisses. Over the last ten months, shares of Hershey are down by more than 20% while the S&P 500 is up by more than 20%. Yet, Hershey’s earnings reports have been quite good.

Certainly, some of the damage has been caused by the soaring price for cocoa. Thanks to heavy rains in west Africa, the price for cocoa has jumped 150% in the past year. In response, Hershey has been able to pass on some of those price increases.

Right now, Wall Street expects that Hershey will have flat earnings growth this year. That may be right, but I highly doubt that flat earnings growth will last long. At some point, cocoa production will return to normal, and Hershey will prosper.

I certainly understand the danger in being too defensive, but I think all Street is currently overdoing its aversion to defensive stocks. The cycle will turn.

Tennant: The Floor Cleaner that Beats the Market

I enjoy highlighting superior stocks that may not be well-known. This week, I wanted to bring Tennant Company (TNC) to your attention. The company “designs, manufactures, and markets floor cleaning equipment.”

Tennant has a market cap of just over $2 billion, and only three Wall Street analysts follow the stock.

A few weeks ago, Tennant reported Q4 earnings of $1.92 per share. That easily beat Wall Street’s consensus (such as it is) of $1.25 per share. In three sessions, the stock gained almost 13%.

Tennant has an enviable track record. Since 2000, TNC has outpaced the S&P 500 by a margin of 881% to 445%.

Tennant has increased its dividend for the last 52 years in a row. I’ll never understand why stocks like this are so overlooked.

What to Expect from This Week’s Fed Meeting

The Federal Reserve is meeting today and tomorrow. The FOMC will release its policy statement tomorrow at 2 pm ET. Don’t expect any change to interest rates. The futures market currently places odds of 99% that the Fed will leave rates unchanged. That sounds about right, maybe a little low.

Along with tomorrow’s policy statement, the Fed will also update its economic projections. I’ll caution you that the Fed has a very poor track record of trying to forecast what the economy will do. Still, it’s important to see what they’re thinking.

There won’t be any Fed meeting in April, but the central bank will get together again in early May. Once again, don’t expect much action. Futures traders say there’s a 93% chance that the Fed won’t make any changes to interest rates.

The earliest traders see the Fed cutting rates is at the June meeting. According to the latest prices, traders place a 60% chance of a rate cut then. That’s still far from certain. We’ll learn more in tomorrow’s Fed statement.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. If you want more info on our ETF, you can check out the ETF’s website.

Posted by on March 19th, 2024 at 8:57 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.