Sept. 14 (Bloomberg) -- Philippe Chaumel beat 94 percent of his peers in the past year by investing in companies that perform the best when the economy is expanding. Now, the Rothschild & Cie Gestion money manager says it’s time to move into defensive stocks.

His Elan Euro Dynamique Fund is cutting holdings of banks and companies reliant on consumer spending and buying Sanofi- Aventis SA, France’s biggest drugmaker, and Groupe Danone SA, the world’s largest yogurt maker, as they trade at the cheapest levels on record. The Paris-based manager is betting that the global economic recovery won’t be strong enough to support gains in so-called cyclical stocks that more than doubled to lead a six-month, 62 percent surge in the MSCI World Index.

Chaumel isn’t alone. BlackRock Inc. fund manager Kevin Rendino bought shares of telephone companies, drugmakers and health insurers because defensive stocks are “incredibly inexpensive.” OppenheimerFunds Inc. portfolio manager Michael Levine is adding to holdings of utilities. Retailers, banks, energy producers and industrial companies are the biggest targets for speculators betting on price declines, according to New York Stock Exchange data compiled by Bloomberg.

“It is time to switch,” said Chaumel, a manager at Paris- based Rothschild, which oversees about $25 billion. “We won’t have a V-shaped recovery. The economic environment will stay tough.”

Citigroup to Caterpillar

Signs that the global economy is pulling out of its first recession since World War II have driven the Morgan Stanley Cyclical Index’s six-month, 165 percent surge. The gauge added 4.5 percent last week, while the MSCI World climbed 4.1 percent as investors speculated that mergers will increase and rising forecasts for oil demand boosted energy companies.

The MSCI World slid 0.1 percent at 5:15 p.m. in New York, dropping for the first time in eight days. The best performing industry groups were defensive stocks, with gauges of health- care companies and utilities climbing more than 0.3 percent. Cyclical shares led the decline, with a measure of raw-material producers falling 0.7 percent.

The cyclical index last week traded at 29.4 times the profit of its 30 economically-sensitive companies from New York- based Citigroup Inc. to Caterpillar Inc. in Peoria, Illinois. The valuation is about double that of MSCI gauges of drugmakers, household-goods producers, telecommunications providers and utilities, the biggest gaps since at least 2002, weekly data compiled by Bloomberg show.

Yogurt, Pampers

Sanofi trades at 7.8 times estimated profit, the cheapest level since at least 2003 compared with reported earnings, weekly Bloomberg data show. Danone was valued at 1.9 times net assets last month, the lowest level relative to the MSCI World since at least 2002. Both companies are based in Paris.

Investors are paying $15.03 for each dollar of profit generated by Danone, Procter & Gamble Co. and 126 other companies in the MSCI World Consumer Staples Index, 45 percent less than the broader market. P&G, the maker of Pampers diapers, has boosted its dividend for 53 straight fiscal years.

The valuations help make defensives a safer bet because any recovery will be “uneven” with the U.S. unemployment rate at a 26-year high and consumer credit plunging the most on record, said OppenheimerFunds’ Levine. Profits at banks, raw-material producers and industrial companies fell more than 21 percent on average last quarter even as the three groups led the MSCI World’s rebound from a 13-year low in March, data compiled by Bloomberg show.

‘Incredibly Inexpensive’

Utilities and health-care companies, the only groups of 10 industries to report higher second-quarter earnings, underperformed the MSCI World by more than 27 percentage points through last week. Phone companies and makers of household products, food and tobacco have trailed by more than 23 percentage points even after posting the smallest profit declines, Bloomberg data show.

“Anything that’s safe is incredibly inexpensive,” said Rendino, who oversees $10 billion in Plainsboro, New Jersey for BlackRock, the biggest publicly traded U.S. money manager. “That’s where a lot of the value is now.”

Qwest Communications International Inc. the local-phone company for 14 U.S. states, is “as cheap a stock as I’ve ever seen in 20 years doing this,” Rendino said. The Denver-based company’s dividend yield of 9.6 percent on Sept. 8 exceeded the average payout of the 1,659 companies in the MSCI World by 3.3 times, the most on record. Qwest’s dividend is 2.6 times the yield on the 10-year Treasury note, weekly Bloomberg data show.

Great Depression

Rendino is shifting into defensives even as strategists from New York-based JPMorgan Chase & Co.’s Thomas Lee to Peter Oppenheimer at Goldman Sachs Group Inc. in London advised investors this month to hold more cyclical stocks as growth accelerates. U.S. companies will halt a two-year slump in profits next quarter, the longest since the Great Depression, according to analyst projections compiled by Bloomberg.

The U.S. economy will pull out of the recession at a faster pace than previously forecast, expanding at a 2.9 percent annual rate in the current quarter, according to the median estimate in a Bloomberg News survey of 61 economists this month. They had projected growth of 2.2 percent in August.

Defensives may “appear cheap because people are moving in other directions,” said Richard Weiss, who oversees about $50 billion as chief investment officer at City National Bank in Beverly Hills, California. “Eventually we’ll be moving into some of the more aggressive sectors, maybe into financials, consumer-discretionary stocks and take advantage of what will eventually be a full recovery.”

Recessions

A gauge of consumer-staples companies from food and beverage producers to toothpaste makers posted the biggest gain among the Standard & Poor’s 500 Index’s 10 industry groups in the six months following the end of the last recession in November 2001, according to data compiled by Birinyi Associates Inc., the Westport, Connecticut-based research and money management firm founded by Laszlo Birinyi.

Utilities were the best performers following the only U.S. recession of the 1990s, climbing 9.1 percent in the six months after the contraction that ended in March 1991, the data show.

In the six months following the 1981-1982 recession, four cyclical industries -- technology, energy, consumer- discretionary and raw-material companies -- posted rallies of more than 21 percent, Birinyi’s data show. The biggest rise among defensive groups was less than half those gains, with utilities adding 9.5 percent.

‘Weak Economic Scenario’

The U.S. economy grew at a more than 7 percent annual rate for five straight quarters following the 1981-1982 recession. Growth will average 2.4 percent next year, according to a Bloomberg News survey of economists this month.

“Clearly the staples and other traditional defensive groups outperform in a weak economic scenario and even in an environment of moderate economic improvement,” said Levine at New York-based OppenheimerFunds, which oversees about $155 billion. “The only scenario in which they underperform is if we get a very strong and sustained recovery, which I would not bet on.”

Consumer spending will be weaker than at the end of previous contractions, Goldman Sachs’ New York-based chief U.S. economist Jan Hatzius wrote in a Sept. 1 note. Wages and salaries, which drive spending, fell 4.7 percent in the 12 months through June, the biggest slump since records began in 1960, Commerce Department figures showed.

U.S. consumer credit plunged by a record $21.6 billion in July, according to a Federal Reserve report released last week. The drop was more than five times as much as estimated by economists in a Bloomberg News survey, as banks restricted lending and job losses made Americans reluctant to borrow.

Stiglitz, Lehman

The U.S. unemployment rate climbed to 9.7 percent last month, the highest since June 1983. That brought the number of Americans thrown out of work since the recession began in December 2007 to 6.9 million people, the most in any post-World War II contraction, data compiled by Bloomberg show.

Joseph Stiglitz, the Nobel Prize-winning economist, said yesterday that the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of New York-based Lehman Brothers Holdings Inc.

Tomorrow is the one-year anniversary of Lehman’s bankruptcy, which exacerbated the global recession. Writedowns and credit losses at the world’s biggest financial institutions since the start of 2007 have climbed to more than $1.6 trillion, data compiled by Bloomberg show.

Short Sellers

Short sellers who borrow stock to sell on the expectation it can be purchased at a lower price before paying back the loan are placing their biggest bets against shares whose profits are most tied to economic growth.

Companies dependent on consumer spending from Chipotle Mexican Grill Inc. in Denver to Red Bank, New Jersey-based homebuilder Hovnanian Enterprises Inc. have the highest average level of short interest at 7.7 percent of their shares available for trading, NYSE data show. Banks and energy producers have the second- and third-highest levels of short interest, respectively, among 10 industry groups.

Telecommunications shares have the lowest ratio, at 1.5 percent, followed by utilities, consumer staples, and health- care companies, NYSE’s data show.

Bond investors also doubt the economy is about to recover, according to the Merrill Lynch & Co. Global Sovereign Broad Market Plus Index. The gauge, which tracks $15.4 trillion of bonds worldwide, gained 0.83 percent last month, the most since a 1.02 percent increase in March.

‘Run Right Back’

“If you’re concerned to the point that you think this economic recovery is not going to be anywhere near the extent that the market is implying, you’re going to run right back into the same spaces that did well in 2008,” said David Heupel, who helps manage $60 billion at Thrivent Financial for Lutherans in Minneapolis and bought shares of Procter & Gamble last week.

P&G, the Cincinnati-based maker of Tide detergent and Pantene shampoo, rose the most in almost six months in New York trading on Sept. 10 after the company’s Chief Financial Officer Jon Moeller said that its sales were approaching an “inflection point.” The shares were valued at 14.2 times earnings last month, a 24 percent discount to the S&P 500 that was the biggest since September 2000, weekly Bloomberg data show.

“We’re always looking for opportunities where valuation is lacking and fundamentals are improving,” Heupel said.

To contact the reporters on this story: Alexis Xydias in London at axydias@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net; Elizabeth Stanton in New York at estanton@bloomberg.net.

Last Updated: September 14, 2009 17:20 EDT