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Although the tobacco sector has been a solid performer for most of this decade, the shares have recently moved into overdrive, aided by a belated awareness by investors and brokers such as Goldman Sachs (GS) that the U.S. economy is slowing down. Since Oct. 8, the S&P Supercomposite Tobacco Index has gained 11.5%, far outpacing a 6% slide in the S&P 500 and a 1.8% decline in the Morgan Stanley Consumer Index. Among the winners in the group over the span are UST Incorporated (UST) , index heavyweight Altria (MO) and Reynolds America (RAI) , up 13.1%, 12%, and 7.9%, respectively. Historically, tobacco, food and beverage and other such groups have been seen as defensive safe havens during times when growth is faltering. The idea is that consumers will keep spending on certain staple goods even when they are cutting back elsewhere. Yet, an unwelcome combination of unfolding fiscal and reemerging legal threats could prove to be a major drag on the sector this time around. For one thing, a flurry of recent reports makes it clear that the housing bust is playing havoc with state and local finances around the country. Just this past week, for example, California Governor Arnold Schwarzenegger said he will declare a "fiscal emergency" over a projected $14 billion state deficit. Municipal officials have often responded to revenue shortfalls by boosting the amounts they rake in from the sale of tobacco products. Indeed, Schwarzenegger has told lawmakers they can help ease the state's budget pinch by passing his new health care plan, which includes a cigarette tax increase. But government budget woes aren't the only threat. Earlier this month, a Minnesota appeals court reinstated a lawsuit filed by smokers of light cigarettes against R.J. Reynolds. Judges ruled that the Federal Cigarette Label and Advertising Act, which bars health claims related to cigarette labeling, "permits claims of fraud," according to Bloomberg. Eight state attorneys general are also suing the second-largest tobacco maker over a nine-page advertising spread in Rolling Stone magazine that used cartoons to promote the Camel cigarette brand. Perhaps the best reason to be cautious right now is the fact that so many analysts view the sector in the same positive light. JPMorgan Chase (JPM) , among others, sees double-digit gains for tobacco shares in the year ahead, while 12 out of 15 analysts covering Altria's shares rate the stock a buy; the others are holds. And even if history and the exhortations of the bulls prove correct in the longer run, the odds of a pullback naturally increase following straight-line moves like we saw over the past seven weeks or so, especially given that the sector had already attracted a bullish crowd. With the approaching year-end likely to spur at least some profit-taking ahead of what is sizing up to be another turbulent year in credit markets (and elsewhere), investors should consider cutting back on tobacco sector holdings. In other words, it's time to exhale. RELATED STORIES Altria Fires Up Cigar Business Altria Beats the Street Revenue Climbs at Altria
At the time of publication, Panzner had no positions in the stocks mentioned, although positions may change at any time.Michael Panzner is a 25-year veteran of the global stock, bond and currency markets who has worked in New York and London for HSBC, Soros Funds, ABN Amro, Dresdner Bank and J.P. Morgan Chase. He is the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes and The New Laws of the Stock Market Jungle: An Insider's Guide to Successful Investing in a Changing World, and is the publisher of the Financial Armageddon blog. Panzner is also a New York Institute of Finance faculty member. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Panzner appreciates your feedback; click here to send him an email.
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