Why You Should Prefer Stocks over Bonds

3 Portfolio Moves You Should Consider Now (Part 4 of 6)

(Continued from Part 3)

So what portfolio moves should you consider making as the second quarter kicks off? Here are three moves to consider to prepare for the next act of the Age of Divergence.

1. Prefer Stocks Over Bonds, But Be Choosy

At BlackRock, we continue to favor stocks over bonds, which are even more expensive, and cash, which offers near-zero returns. But within equities, we remain cautious of bond market proxies, like Utilities. They are both expensive and extremely sensitive to even a small change in rates. We believe greater value can be found in sectors positioned to benefit from economic growth, such as technology and large integrated energy companies.

Market Realist – Avoid bond proxies like utilities.

With the rate hike likely to take place in the second half of the year, you need to avoid bond proxies like utilities and REITs (VNQ).

The graph above shows the price movement of the Vanguard Total Bond Market (ETF) and the Utilities SPDR ETF (XLU) since October 2013. The two move in a similar path, while not in lockstep. Another case against bond-proxies, is that they are trading at rich valuations.

The graph above shows the current PE ratio (price-to-earnings ratio) for the S&P 500 Index (SPY) and the sectors that make up the index. Energy (XLE) and financials (XLF) are currently quite cheap. Financials have had a decent earnings season so far, and they’re looking attractive at the moment. With oil prices seemingly bottoming out, you could make the case for energy companies at their current valuations.

While the tech sector (QQQ) appears expensive on its face, you could consider the sector since it’s poised to navigate through the period of rising rates with ease—given mature tech companies’ sheer financial strength. Currently, the sector is trading at a premium of 6% to the S&P 500. Historically, the premium is ~15%, which means that the sector is relatively cheap compared to the S&P 500.

Meanwhile, the defensive sectors—including consumer staples (XLP), consumer discretionary (XLY) and healthcare (XLV)—appear expensive.

Continue to Part 5

Browse this series on Market Realist:

• Part 1 - Why the US Dollar Could Strengthen Further

• Part 2 - How a Stronger US Dollar Has Affected Large-Cap Stocks

• Part 3 - Yields Could Remain Low Despite the Looming Rate Hike