The market is getting more defensive, and the reasons why could be very worrisome

Stocks are within striking distance of all-time highs, but two strategists say a defensive posture is best for investors right now.

The S&P 500 (^GSPC) is trading just 4% away from its record highs of 2,134.72. Yet a look at individual sectors in the index reveals uncertainty about the market’s overall strength.

“The discretionary sector is starting to really break down versus staples despite the fact that the prices are right near all-time highs for the S&P [500],” said Mark Newton, founder of Newton Advisors.

The ETF tracking the S&P 500’s consumer discretionary sector (trading under the symbol XLY) is down 1% for the year, while the more defensive consumer staples sector’s ETF (trading under the symbol XLP) is up 3%.

“Sectors like consumer staples have just hit brand-new all-time highs,” Newton said. “Campbell Soup (CPB), Altria Group (MO), and Philip Morris (PM) — you see all these stocks surging towards new highs ... Ordinarily in a ‘risk on’ type environment you wouldn't expect the discretionary [sector] would be lagging as much as it has.”

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“The market is slowly starting to shift from a bullish environment to a sideways pattern. Eventually this could be problematic and lead the indices down in the years to come,” Newton warned.

Brian Barnier, principal at ValueBridge Advisors and founder of FedDashboard.com, contends that fundamentals for both sectors indicate consumer discretionary stocks should be doing better than staples — but they're not.

Barnier maintains that with the Fed no longer increasing its balance sheet, the stock market is directionless. From 2009 to 2014, the Federal Reserve increased its total holdings of Treasury notes and mortgage-backed securities (MBS) from $1 trillion to $4 trillion. During that time frame, the S&P 500 gained nearly 170%.

“There is one big macro thing and that's the Fed,” said Barnier. “That has accounted for more than 90% of the drive up in the S&P 500.”

Meanwhile, revenues have not seen that kind of growth, Barnier argues. He calculates that about half of all companies in the S&P 500 saw revenue declines in the first quarter of 2016 compared to the same time in 2015. Barnier sees some parallels with the tech bubble from a decade and a half ago where stock prices soared despite relatively modest revenue growth.

“The difference is back then, it was driven up by a few tech companies,” he said. “Now it's much broader so the potential scare is also much greater."

“Both technicals and fundamentals are suggesting that the market is slowly starting to change,” said Newton. “The next few months are going to be very interesting to see how everything is going to unfold.”

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