The stock market’s rally through October 21 would have been the second-best month this year behind July, but this time around investors are being more cautious about what they buy, preferring stronger beta stocks more so than in previous rallies, according to Citigroup Inc (NYSE:C)’s US Credit Weekly.

Stock market rally defensive

“In many respects, October hasn’t marked a huge departure from the pattern evident in July’s rally in that it’s been remarkably defensive in nature,” writes Citi analyst Jason Shoup. “Corporates and financials are leading the way as one would expect during any rally, but the higher beta portions of the market aren’t pulling their weight to the extent we’ve seen in past rallies. That’s particularly the case at the long end of the curve, where triple-B corporates have outperformed single-A corporates by less than 1bp and where long-end financials have only outperformed by 2bp.”

MTG big corp spread tenor 1013 Stock rally

In the same vein, the spread between 30-year senior and subordinate bank debt has stayed steady, and the 10-year spread has only fallen slightly. The rally in CDS has been even more led by beta than rallies in 2011 and 2012 with the top 20% of the CDX in terms of beta accounting for 50% of the rally.

senior sub spread diff 1013 stock rally

Tapering might affect investors

Shoup thinks that investors are trying to take advantage of the rally without exposing themselves to low quality investments that might suffer once tapering kicks in. “Investors are doing the prudent thing by buying into the rally but with an up-in-quality bias on the expectation that central banks will keep the liquidity traps on for a while longer.”

After a month of almost unanimous bullishness from analysts, it’s good to see that investors are preparing for possible setbacks when the Fed eventually tightens its policies, and that all the encouragement to take on more risk hasn’t been followed blindly. Shoup thinks the risk of QE ending sooner than anticipated is still very real, but it’s hard to imagine how that could happen. Fed Chair Ben Bernanke won’t step down until early next year and he hasn’t shown any interest in pulling the trigger himself, and the September numbers give him plenty of justification for holding off.