Defensive sectors, such as consumer staples and utilities, often trade at valuations that are in excess of broader equity benchmarks. That is the price of admission for those sectors’ above-average dividend yields and, usually, low beta traits.
Currently, staples stocks sport valuations on par with the S&P 500, but some analysts believe the sector’s multiples could contract by a significant margin. The Consumer Staples Select SPDR (NYSEArca: XLP), the largest ETF tracking the consumer staples sector, is down more than 11% year-to-date.
Some market observers believe defensive sectors are currently offering decent value. The rate-sensitive Utilities Select Sector SPDR (NYSEArca: XLU) has been better than staples funds this year, but is still saddled with a year-to-date loss.
“To some extent, weakness in these two sectors makes sense. Both are classic dividend plays, and accordingly sensitive to higher rates,” said BlackRock. “As the yield on the 10-year Treasury has climbed towards 3% —a four-year high—you would expect these sectors to under-perform. However, the magnitude of the out-performance is worth noting. Given how much these sectors have trailed the broader market, for the first time in years valuations are starting to look reasonable.”
Looking for Value
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.