Monday, June 17, 2013

"The Low Beta Bubble"

I had the chance last Friday to catch up with Merrill Lynch's chief equity strategist Savita Subramanian at a luncheon meeting.

Savita thinks that the widespread investor interest in high dividend paying stocks has left the group vulnerable to a correction.

With interest rates at historic lows, investors have flocked into sectors like telecom and utilities, and pushed valuations of these stocks to historically rich levels - a "low beta bubble", as she put it.

On the other hand, Savita feels that investors are ignoring sectors such as technology and industrials, where underlying fundamental are steadily improving.  Many of the companies in these areas, however, pay either meager dividends or none at all, and so have been left behind in the market rise this year.

As Savita put it:

"We would be a seller of low beta stocks with high earnings volatility such as telecom, and a buyer of high beta stocks with low earnings volatility such as technology."

Savita is also interested in energy stocks, which are "cheap and unloved" by investors in her view.  She feels that much of the "bad news" about energy prices is already in their stock prices.

About a year ago, Savita put out a price target of 1600 for the S&P 500 by the end of 2013.  At the time she was viewed as being wildly bullish.  Now that the S&P is trading at 1640, and she has not changed her view that the S&P will end this year at 1600, she is viewed as one of the more bearish on the Street.

So which is it?

Savita implied that she might be inclined to bump her year-end S&P target to 1650, but is reluctant to do so at this point. In her view, all that has happened so far in 2013 is the stocks that were expensive at the beginning of 2013 (i.e., the high dividend-payers) have gotten more expensive, while the rest of the market has languished.

She sees the broader market averages trading in a range for the rest of the year, but with sector leadership changing dramatically in the months ahead.

Many of Savita's comments echoed those of Vadim Zlotinov of Bernstein, who was the subject of my last post.  Their work clearly indicates that vulnerability of high dividend paying stocks, but absent a dramatic rise in bond yields it may be some time before we see any significant shift in sentiment from investors.