In the last weeks of the year, investors have piled into traditionally defensive stocks, spurring a rally that some believe may lose steam early in 2022.
Consumer staples, real estate investment trusts, healthcare and utilities are some of the top performing sectors in the S&P 500 this month. Each of the sectors, which are viewed as popular destinations during times of uncertainty, have risen by 9% or more in December and outpaced the broader index's gain of about 5%.
The energy and information technology sectors of the S&P 500 are up 2.9% and 3.3% for December, according to the year's best performers. The broader index is up 27% in 2021 and on track for its third straight year of double-digit gains.
The case for caution was bolstered by the fact that investors had had plenty of reasons to turn defensive in recent weeks, as uncertainty over the new Omicron variant, soaring inflation and a hawkish shift at the Federal Reserve.
The Consumer Staples Select Sector SPDR Fund's net inflow was $697 million in December, putting it on track for its strongest month since July, according to Refinitiv Lipper data. In November, the Health Care Select Sector SPDR Fund pulled $1.1 billion, which was its best month since July, resulting in net inflows of $963 million.
Zachary Hill, head of portfolio management at Horizon Investments, believes that defensive stocks may reflect fund managers taking profits on winning positions and reallocating funds toward beaten-down names, a common year-end practice for many investors.
After a good year for stocks, it's not terribly surprising to see some of the laggard sectors. Hill said that they did a little bit better. That theory makes sense this year, with the energy and information technology sectors of the S&P up 48% and 33% for the year. The performance of utilities, REITs, healthcare and consumer staples isn't close to the year-to-date performance.
The average gain for the month since 1990 for utilities was 1.9%, but fell 0.25% on average in January, according to a CFRA Research analysis.
The data shows that Information technology has the worst performance in December with an average gain of 0.67%, but it has logged an average gain of 2.83% in January.
Information technology was the worst performer in December with an average gain of 0.67%, but in January has a gain of 2.83%, according to the data.
A threat to the recent rally in defensive stocks could also come from higher Treasury yields, which may accompany a more hawkish Fed and dim the allure of utilities and other sectors that draw investors with their comparatively high dividends, said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management.
The yield on the benchmark U.S. 10 year note is expected to rise to 2.08% in the next 12 months, according to an early December Reuters survey of over 60 fixed-income experts. The yield on the 10 year note was 1.50% on Friday. The Fed has signaled a faster tapering of its asset purchases and three rate hikes for 2022.
A more aggressive Fed could weigh on the S&P 500, where valuations are at their highest level in nearly two decades, according to others.
On December 20, analysts at Morgan Stanley said they favor defensive stocks over cyclicals, as the Fed began paring back monetary accommodation from markets.
The bank's analysts wrote that growth stocks would be more vulnerable to tapering than defensive ones given their much higher valuations.
Hill, of Horizon Investments, believes that stocks will be more volatile next year after a relatively calm 2021. The S&P 500's one month volatility averaged 12.5 for the year, the lowest since 2017 according to Refinitiv data.
He said that the outlook for stocks is broadly positive and won't be nearly as straight as we had this year.