Bored to Wealth

 | Mar 27, 2014 | 4:30 PM EDT
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I have been a high school debate coach, so I fully understand that the plural of anecdote is not data, but sometimes one person's story or view can spark a valid thought.

On Wednesday, I had a conversation with a friend; I'll call him Mike. Mike is a lucky man. He is not yet 40, but successful business ventures have left him with enough income and savings that, barring disaster, he should be set for life.

He recognizes that, in investing terms, his main goal should be to not jeopardize that situation, so invests the vast majority of his money in cheap, index tracking ETFs that, given the decades he has to retirement, he basically buys and forgets.

However, Mike enjoys playing the market, so he keeps a small percentage of funds in an account for more active, and more risky, investing. This account has done well as he has focused on small biotech and high tech stocks, particularly in the area of SMAC (social, mobile, analytics and cloud) names. Yesterday, however, he spoke of frustration at finding a home for his money and talked of parking it in "boring things," such as General Electric (GE) and Wal-Mart (WMT).

The problem, he said, was that value had become almost impossible to find. He's not alone in that view; many prominent analysts and pundits (including this site's own Jim Cramer) have begun to make noises about froth in some areas of the market. The reason I took notice in this case is that this is money specifically put aside to take on risk by somebody who enjoys just that, but even he wanted to dial back.

I can see the argument that there is something bubbly about a few sectors, and yesterday's initial public offering (IPO) of Candy Crush maker King Digital Entertainment (KING) could well be the first indication that a pop is coming, but I cannot escape data that show that the U.S. and global economies, and, therefore, stock markets in general, are still in recovery.

In fact, after five years of slow, grinding improvement, I believe more rapid expansion is likely over the next couple of years. In that scenario, I don't want to be left out, but some damage to the markets (should Cramer and others be correct) seems almost inevitable. Mike could be right; defensive could be the way to go.

The problem that this presents for investors, however, is that many of the traditional boring or defensive sectors won't work this time around. With the Fed acknowledging that interest rates must at some point be raised, yielding instruments such as bonds, telecoms and utilities hardly look to have a rosy immediate future. In addition, last year's spectacular year for stocks left very few opportunities for value seekers. A look at the Morningstar table of sector returns, however, does suggest a couple of areas that could benefit from continued growth -- even with volatility in some sectors.

Stock Sectors -- Total Returns
Source: Morningstar

In the One Year column, with the exception of real estate which has its own problems, the worst performing sectors have been basic materials, energy and consumer defensive. All of these are defensive sectors, which should come as no surprise, as last year's gains ushered in more of a "risk on" approach. If there is a bubbly situation that pops, even a small one, then these defensive sectors will benefit. If there isn't, they could still do well as value seeking causes them to catch up.

Splitting between one large, steady company in each sector would be a defensive position that still had room for appreciation in an economy where fundamentals continue to improve. I would personally favor DuPont (DD) in materials, Marathon Petroleum (MPC) in energy and the aforementioned Wal-Mart in consumer defensive.

The individual picks, however are less important here than the strategy. The struggle that Mike and those like him are having trying to find value in risky investments doesn't mean that markets are set to collapse, but it may indicate trouble in some sectors. Even though an anecdote led me to the conclusion, a little prudent reduction of risk in your portfolio makes sense for a while.

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