Cyclicals vs defensives

The premium commanded by defensive shares over cyclicals seems to have disappeared over the last couple of months. Since the beginning of March, Greene King has advanced by 27%, Next by 30%, Taylor Wimpey by 150%, and the banks by up to 200%.

On the defensive side my portfolio has some bonds (heavily weighted towards banking, so not that defensive - up 9% since March), Diageo (17%) and Tesco (9%).

I'm not ready to sell out of my cyclical shares yet - I still think they're below fair value - but I think my next investment will be into some more defensive shares.

I'm looking at British American Tobacco (BATS) and GlaxoSmithKline (GSK). By sheer coincidence, Neil Woodford was quoted in the Times today as saying he thought these two plus National Grid (NG-) were some of the best buying opportunities out there. So I'm also taking a look at National Grid :-)

There is also a bit of portfolio maintenance to be done:

• Take up the TW open offer, and then probably sell out completely once the shares start trading on 1 June. Anything over 33p (about half book value) would be OK - less than that and I'll probably hold onto them.
• Top slice Barclays and reinvest the proceeds in Maxima. Maxima is underweight compared to my other small-caps, and Barclays is over-weight compared to the other banks, so some reallocation makes sense here.
• Crystallise a capital loss on Zirax, to offset some of the capital gain I am making this year (through my job, not my stellar stock-picking). Looks like there's a grey area whether I can repurchase them in my wife's name within 30 days without them being picked up by the bed and breakfasting rules... I'll probably get away with it.
• If I can get a decent price (~110p) sell out of my Lloyds ordinaries, since I have quite enough exposure through the preference shares.

That would leave me roughly:

• 6% in bank ordinaries, 5% in bank prefs
• 7% bonds
• 11% small caps
• 13% Berkshire
• 8% each in GNK, Diageo, Next, 6% in Tesco
• 11% in emerging markets, 9% each in Europe and Asia

In the medium term I'm looking to increase the amount in emerging markets, Europe and Asia. I may add some more bank preference shares.

British American Tobacco

Tobacco looks like a good business - highly cash-generative, stable returns, brand loyalty. BAT doesn't have a lot of debt, and at its current price of 1700p is on a yield of 5%. It has a history of growing earnings at about 10% per year. The P/E ratio is a little steep at 14, but they can pay most of that out and still grow, so those are good-quality earnings.

GlaxoSmithKline

At 1050p this is on a P/E ratio of 12 (10 if you strip out some exceptionals), a dividend yield of 5.3%. I've looked at them before, and noted that their R&D and marketing expenses aren't capitalised, so like BAT these are good-quality earnings.

National Grid

Dividend yield of 5.65%, P/E ratio of about 12 (adjusting for exceptionals). Very high Return on Equity. Very stable revenue.

Conclusion

I like all three of these shares. They're not glitzy, but they earn good money and should be safe. Comparing them to some tremendously good value small caps, I don't think they are necessarily going to outperform. But comparing them to cash or bonds, they should. And that is the more realistic choice I face - I'm already heavily invested in quite risky shares, and I need some balance to my portfolio. Currently that's provided by having plenty of cash, but I'm steadily investing it, and need to buy some safer shares too.