Consumer staples stocks are supposed to be a safe haven, but investors have found little shelter in the sector thus far in 2014.
The Consumer Staples SPDR (XLP) has fallen 6.7% since the start of the year, underperforming the -5.2% return of the SPDR S&P 500 ETF (SPY). This isn’t the way things are supposed to go for a sector that’s expected to have defensive characteristics when market conditions get rough.
At this stage, however, the consumer staples sector has begun to look more attractive than it has in more than a year — a potential gift for those looking for lower-risk ways to invest in stocks.
Consumer Staples: A Budding Value
The primary issue weighing on consumer staples shares since the middle of last year has been, more than anything else, valuations. At this time one year ago, consumer staples was the most richly valued of all 10 major sectors despite having lower projected growth than the market as a whole. As late as November, the sector was still trading well above its historical valuation premium relative to the S&P 500 Index.
In the past three months, valuations have begun to normalize — but not necessarily for the reason that might initially jump to mind.
The selloff in consumer staples has occurred in tandem with rising worries about economic growth and the downturn in the stocks of retailers and lower-end restaurant operators. This creates the illusion that economic conditions are the key issue, but that’s not necessarily accurate — after all, companies in the consumer staples sector sell non-discretionary items.
Instead, the key catalyst for this valuation correction has been the sharp increase in natural gas prices.
See, the consumer staples sector tends to have a much stronger negative correlation with natural gas prices than the rest of the stock market because higher heating bills tend to pull cash from the same non-discretionary spending pool that consumers use to purchase everyday items. And when natural gas spikes, as it has this year, the negative correlation becomes even stronger.
This is actually good news for stock investors right now, since it has brought valuations for consumer staples stocks down to more reasonable levels.
FactSet reports that the valuation for the sector as a whole came down to 16.3 times forward earnings at the end of January, from 17.2 at the end of December — a drop of more than 5% in just one month. As a result, the overall sector valuation has moved in line with its 10-year average of 16. This indicates that the consumer staples sector is now a more attractive place to find bargains than it has been in quite some time.
Improved valuations aren’t the only thing that the group has going for it. Even though consumer staples have lagged in the down market so far this year, the return of risk to the stock market should support demand for defensive, less economically sensitive investments. Once the price of natural gas settles down — as it inevitably will, with production remaining high prices already up so much in 2014 — the defensive nature of consumer staples shares should become more apparent.
What’s more, the sector offers a competitive yield. XLP currently yields 2.6%, above the 1.9% of SPY and in line with the 2.7% yield on the 10-year Treasury. With the bond market having settled down, most yield plays are coming back into vogue in 2014. Higher-yielding segments have performed well in the environment of falling bond yields, with REITs, utilities and MLPs all outperforming the broader market year-to-date.
The common ground among these sectors is that unlike consumer staples, none of them are hurt by the rising price of natural gas. This also bodes well for consumer staples if natural gas prices begin to trend lower as the winter winds down.
Investors need to be selective in the staples group, since certain stocks — especially PepsiCo (PEP), General Mills (GIS) and Procter & Gamble (PG) — continue to exhibit vulnerable chart patterns. Nevertheless, the recent downturn means it’s time to put this sector back on your radar screen.
As a starting point for further research, the table below provides the current data on 20 of the largest stocks in the sector:
|Stock||ticker||ytd return (2/5)||12-MO Earnings Ests||Fwd. P/e||Yield|
|Procter & Gamble||PG||-5.4%||8.7%||16.6||3.2%|
|Phillip Morris International||PM||-11.4%||0.0%||12.8||3.8%|
|Mead Johnson Nutrition||MJN||-12.1%||11.8%||18.6||1.8%|
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.