BofA strategist favors defensive stocks

By Caroline Valetkevitch

NEW YORK (Reuters) - With inflation worries pressuring U.S. equities, investors may find a safe haven in healthcare, consumer staples and financial stocks, Banc of America Securities' chief investment strategist said on Tuesday.

Tom McManus told the Reuters Investment Outlook Summit in New York that he has been raising his allocation in defensive stocks, which tend to perform better in periods of uncertainty.

"That has underscored our desire to add defensive stocks -- the bonds of the stock market -- steady companies with strong earnings and geographic diversification," said McManus, who declined to identify individual stocks.

"Stocks like these are cheaper than they've been in 15 years and right now it seems the market is prepared to rotate into these," he said.

The recent sell-off in equities has seen investors shifting from energy, steel, and precious and base metals stocks, the key drivers of the stock market as commodity prices hit record highs.

An S&P index of health-care stocks .GSPA is down about 1.5 percent while the broad Standard & Poor's 500 .SPX index is down 7.6 percent since early May, just before the recent routing of stocks began.

Economic data has investors fretting over the prospect of further increases in interest rates. Until May, the market was awash with talk of a likely pause in rate hikes, but that has dissipated as U.S. price pressures mount.

Last week, the European Central Bank raised rates, which coincided with rate hikes in several emerging markets including South Africa and India.

"In the (first quarter) we saw a worldwide embracing of commodity-driven earnings and profit growth. That clearly had ramifications about how central banks viewed the world," McManus said.

He said his firm expects the Fed to raise interest rates to as high as 5.75 by the end of this year from a current 5 percent.

His model asset allocation portfolio recommends that clients put 60 percent of their holdings into equities, 20 percent into cash and 20 percent into bonds.

Within the financial sector, McManus said he likes insurance companies rather than banks, and within consumer staples, he likes foods, beverages and products consumers buy that are not especially cyclical.

"We've seen pressure on discretionary spending at the low end, and as housing market concerns start to spread and the stock market declines there will likely be a wealth effect -- it will crimp consumer discretionary spending a bit further up the food chain," he said.

McManus' target on the S&P 500 index is 1,335 for November 2006. The index closed at 1,223.69 on Tuesday, and is down about 2 percent for the year.

"I still think in 12 months time we will be higher, but we could be lower before we go higher," he said.