Stocks ripe for defensive switch

By Dominic Lau and Blaise Robinson

LONDON (Reuters) - Shares in telecoms and utilities have returned to the top of European equity investors' menu, signalling that a shift away from outperforming financials and automakers may be afoot as the economic recovery matures.

A move from cyclicals to defensive stocks such as drugmakers, telecoms, and food producers, which have better ability to weather the economic downturn, would be akin to calling an end to an eight-month-old stock market rally.

And many investment managers, who had missed the early part of the rebound, prefer to stick to the best performing shares until the year end for fear of falling further behind in this year's performance.

But a growing numbers of investment banks have urged clients to look to some defensive laggards, as 2010 could be volatile with central banks expected to withdraw their ultra-loose monetary policy by the end of next year.

"The market is starting to rotate away from (cyclicals) towards the opposite ... where valuations are lower, where the performance has been much worse," said Philip Isherwood at Evolution Securities in London, who feels that the market has moved from discounting recession to discounting recovery.

The rally which has seen the pan-European FTSEurofirst 300 .FTEU3 rebound 57 percent since early March has been led by miners, banks, insurers and construction stocks -- the worst hit during the financial crisis in 2008.

That has seen some sectoral valuations, as measured by one-year forward price-to-earnings (P/E), rise above their pre-crisis level in 2007.

DEFENSIVES OUT OF DOLDRUMS