When the market and the economy plunged into an abyss in 2009, we knew we were in a new world. It didn't take too long for PIMCO to coin the term "New Normal", which was its description of what a post-apocalypse economy might look like (and a fairly accurate one!). Investors took their cue and anointed two assets as "safe": bonds and gold. Both of those asset classes provided very strong returns, but in 2011 the "anything but equities" crowd shifted into a single stock that many discussed as a potential "asset class", Apple (NASDAQ:AAPL). The fear trade has eroded, but reflation is far from being fully embraced. Once again, investors are crowding into a part of the market seen as insulated from the risks of global economic contraction, Consumer Staples (NYSEARCA:XLP).
XLP Goes Parabolic
The story of Q1 was the dominance of non-cyclicals, with Healthcare (NYSEARCA:XLV), Utilities (NYSEARCA:XLU) and XLP leading the market higher. While this type of leadership is rare, as these sectors tend to outperform in falling markets, it has continued further, as Q2, just two weeks old, has seen a 1.25% advance in the price of the S&P 500 (NYSEARCA:SPY) but continued leadership from the low-beta sectors:
Telecom Services: +4.51%
Health Care: +4.08%
Consumer Staples: +2.36%
The more cyclical sectors have actually declined in price so far in April:
Info Tech: -.63%
The rubber band has certainly been stretched, as we can see the price spike in XLP:
XLP data by YCharts
Is this parabolic? It's hard to tell, but the percentage change over the past few months rivals the move from 20 to 24 four years ago from extremely depressed levels. It looks parabolic to me, but let's look at it a different way. In this chart, I take the daily prices of XLP since its inception in 1998 and compare them to the price 50 days prior:
While it's not so common to see a 10% move over 50 trading sessions, what makes the most recent ascent so interesting is that it follows a period where it based at close to zero. Historically, spikes have followed plunges. The last time the rate of change was -10% or more goes back to August 2011, when the market plunged following our budget problems and concerns about Europe.
Up 16.5% so far in 2013, or about 1.5X the improvement in SPY, outperformance is nothing new for XLP. Here is a longer-term chart of the two:
XLP data by YCharts
From the very low in March 2009, XLP is up 111%, capturing over 81% of the rally in SPY. The bottom-line is that "low beta" XLP is quite advanced in its trend of dominating the overall market.
XLP Fundamentals and Valuation
The sector has a market cap of $1.569 trillion, or 11% of the S&P 500. On average, these are fairly large companies compared to the typical S&P 500 member, as the 42 names represent just 8.4% of the companies in the index. S&P breaks them down into the following categories:
Beverages (Brewers, Distillers & Vintners, Soft Drinks)
Food & Staples Retailing (Drug Retail, Food Distributors,Food Retail, Hypermarkets & Super Centers)
Food Products (Agricultural Products, Packaged Foods & Meats)
On a market-cap weighted basis, the sector has a forward PE of 17.2X, which is 120% of the 10-year median. For comparison, the S&P 500, at 14.7X, trades at its 10-year median. On an EV/EBITDA basis, the sector trades at 11X, and it offers a dividend yield of 2.7%.
Looking at the average Consumer Staples company, the PE rises to 18.2 and the EV/EBITDA to 11.4X, while the dividend yield falls to 2.3%. What's going on here is that the larger companies tend to offer higher dividend yields. As far as the PE, WMT brings down the average.
Looking a bit deeper, only one stock has declined in 2013: Whole Foods Market (NASDAQ:WFM), which has lost just 3.5%. Of the 41 stocks that have rallied, 35 have outperformed the S&P 500. The best stocks, all up more than 30%, have been:
Avon Products (NYSE:AVP)
Constellation Brands (NYSE:STZ)
Hormel Foods (HRL)
Campbell Soup (NYSE:CPB)
To be fair, the performance of these stocks isn't necessarily just a blind stampede, as there is an operational turnaround at work at AVP, a huge deal for STZ, a recovery from a disaster and a brave new alliance for WAG and new management at CPB. I have followed HRL for a long time, and this one has been spiked by not only a smart acquisition (Skippy) but also the M&A potential following the Heinz (NYSE:HNZ) deal. But, 20 PE? You have to go back to 1998 to find that high a valuation.
Let's look at one of the larger stocks, PG:
Let's take it one panel at a time. In the top, we can see how earnings have stalled the past few years as global growth has slowed and pricing pressure has been strong from private labels. In the middle panel, we see how the PE has moved from a low near 13 to the current 19.3X. This is well below the 22PE peak level pre-Great Recession. The bottom panel, though, adjusts for the balance sheet - the EV/EBITDA is at a historical high for the past decade.
I think that PG is pretty representative. In a market of cheap stocks, it's not so cheap but not extremely expensive either. Many may not remember, and I don't expect this to happen again, but PG and stocks like it traded in excess of 30PE at the turn of the century.
I think that current analyst consensus estimates for the group are helping to draw in buyers. According to Baseline, the average stock is expected to grow EPS by 8% this year and then 11% in 2014. This sounds a lot better than the 3% for the S&P 500 in 2013 and 7% in 2014. On a market-cap weighted basis, the XLP EPS growth is just slightly lower at 7% in 2013 and 10% in 2014.
What's Next for XLP?
So, the price move has been somewhat extreme, but, as the information conveyed in the previous section suggests, the valuation isn't exactly extreme. Nor are the fundamentals looking too negative. With that said, one could have maintained a similar position regarding AAPL last year (though the fundamentals did change), as its peak valuation only equaled the S&P 500 at the time, at about 13.5X on a PE basis (and this doesn't account for all that cash). Look at how it performed after going parabolic in 2012:
AAPL data by YCharts
That's what's called a round-trip. It's actually worse than it looks, though, as not only has it retraced to its late 2011 peak but the opportunity cost has been high, as the S&P 500 is up 28% while AAPL is up just 1% over the past 18 months.
GLD data by YCharts
Gold (NYSEARCA:GLD) shows a similar story, a complete round-trip. As an aside, this is somewhat surprising that it is breaking down given the aggressiveness by our Federal Reserve as well as Japan. The point is that a parabolic jump in mid-2011 has been followed by sideways action. Again, the opportunity cost isn't apparent, but stocks rose sharply since GLD peaked.
Continuing a long trend of crowded trades in parts of the market seemingly immune from the risks of global economic contraction, investors have bid up Consumer Staples and other low-beta parts of the market. I don't expect that investors in XLP or its constituents will suffer capital losses like late-comers to the GLD and AAPL parties. More likely, they will endure an opportunity cost, sitting in relatively expensive stocks that lag the rest of the rallying market. This might be a good time to rebalance, reallocating out of Consumer Staples and other less cyclical parts of the market in order to take a little more risk. Or maybe into GLD or AAPL!
Additional disclosure: The author is exiting WAG from one or model portfolios he manages at Invest By Model on 4/15