After sagging to end 2016, the Consumer Staples Select SPDR (NYSEArca: XLP) and the Vanguard Consumer Staples ETF (NYSEArca: VDC) along with rival consumer staples exchange traded funds are surging to start 2017.
For example, XLP, the largest staples ETF is higher by nearly 7% year-to-date. The combination of the expected interest rate hikes by the Federal Reserve and a stronger dollar were seen as potential drags on rate-sensitive consumer staples companies that derive significant portions of their revenue from ex-US markets.
Amid fears of rising interest rates and concerns that the sector is overvalued even relative to its lofty historical norms, the consumer staples sector has recently encountered some headwinds. Defensive sectors often trade at premium valuations relative to the broader market and that is certainly the case at the moment with the consumer staples and utilities groups.
“Valuations are expanding, but earnings-per-share growth isn’t. Sales and earnings are ‘sub average,’” said Bank of America Merrill Lynch about the staples sector in a note posted by Crystal Kim of Barron’s.
Staples stocks are comparably valued to their consumer discretionary peers, but some market observers argue that possible increases in household debt would make staples more attractive while wage growth would likely benefit both consumer sectors.
Related to interest rate speculation, there is another problem for staples stocks: The rising dollar. Over the past several weeks, the greenback has caught fire, which is not good news for the staples sector because many of the names found in ETFs like XLP generate significant portions of their sales in international markets.
“Both our Food & Beverage and Cosmetics, Household & Personal Care (HPC) teams point out that cost savings and self-help have driven earnings growth in recent years, which could continue. But they note that many of these cost savings programs have already been in place for a number of years, and with stagnant sales, they expect continued consolidation in the sector in 2017. Increased activism may also benefit some names in the space. Within Tobacco, our team expects fundamentals to remain solid but less positive vs. 2016, and that domestic stocks could remain in favor given potential for tax reform, US consumer strength, and a stronger dollar,” according to the Bank of America note seen in Barron’s.
Also boding poorly for staples is the fact that cyclical sectors, such as industrials and technology, have been market leaders for the past several months. That could be a sign investors are comfortable with higher beta groups over defensive equivalents.
For more information on the consumer sector, visit our consumer staples category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.