Defensive sectors such as healthcare and consumer staples were the best performing industries with the more cyclical materials group performing worst of late.
Investor sentiment on equities appears to be improving, with inflows to equity mutual funds turning positive early in 2013 for the first time in years, but investors do not appear to have confidence in a true recovery in global economies.
Investors seem to have been forced into equities by the lack of return available in other asset classes and have thusfar restricted their search to those equities they expect to show resilience in a potential market downturn.
However, this view has driven the valuations of more defensive stocks, particularly large, well-known companies, to unattractive valuations relative to the overall market.
This valuation premium may make it difficult for such stocks to preserve capital as well as they typically do in any potential market selloff.
Toll roads and electricity grids are relatively immune to the economic cycle but such businesses operating in peripheral European countries remain attractively valued. Large integrated oil companies have tangible assets, resilient cashflows and fortress balance sheets and during the late 2008 market plunge they preserved capital nearly as well as consumer staples stocks.
However, they remain attractively valued with single digit price-to-earnings ratios and robust yields.
In addition, the blossoming of a dividend culture in the US technology sector, long a wasteland for the income investor, has also provided opportunities for defensive businesses at low valuations.
Also, real estate investment trusts are a relatively defensive business with tangible assets and cashflow generally driven by long-term leases.
Real estate investment trusts that serve the healthcare industry are particularly defensive due to the consistent nature of end demand yet such businesses offer attractive valuations and high yields as they are smaller and less well known than global pharmaceutical companies.
The overvaluation of large, well-known, defensive equities has created something of a challenge for investors attempting to maintain balance in a portfolio, but still adhere to a disciplined approach to valuation.
While the trend of money flowing into defensive income stocks is strong and may last some time, ultimately valuations do matter and the current overvaluation of defensive income stocks is unsustainable.
In addition, investors that have been forced into defensive income stocks by the lack of income available in the bond market may well return to bonds if newspaper headlines are again dominated by the European sovereign debt crisis and/or a hard landing in China.
But the more likely outcome, in our view, is that the economic recovery in the US persists amid a recovering housing market, China maintains a high single digit GDP growth rate while Europe avoids depression.
We feel investors will ultimately regain the confidence to look beyond the handful of favoured stocks they perceive as safe to the broader group of much more attractively valued, if somewhat more cyclical or obscure, equities.