Consumer Staples: Cheap and Undiscovered

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by: Market Blog

The sharp decline in the share price of Shoppers Drug Mart Corp. (Toronto: SC.TO) is one more reminder of what a big disappointment consumer staples have been recently.

These stocks are supposed to perform well during dismal economic times because people still want soap, cigarettes and soda even when they’re unemployed. Unfortunately, if you had bought a basket of consumer staples stocks at the recent low point for the stock market, in March, 2009, you would be looking at bittersweet returns right now.

U.S. consumer staples have risen 44 per cent (in U.S. dollar terms) from the bottom. Sounds good, until you consider that is one of the worst performances among the 10 subindexes in the S&P 500. The S&P 500 has risen about 76 per cent over this period and consumer discretionary stocks – which sell stuff people don’t really need – have risen a remarkable 118 per cent.

In Canada this trend is even more pronounced. Here, consumer staples are dead last in the rankings, returning just 8 per cent over the past 13 months. Meanwhile, the S&P/TSX composite index has surged nearly 60 per cent.

Consumer staples did what they were supposed to do during the depths of the recession: They stayed profitable and maintained their dividends. But during the market’s rebound, investors were attracted to riskier, cyclical stocks, such as financials, technology companies and commodity producers.

These preferences could change, and soon, with the start of interest rate increases. As the thinking goes, higher rates mean steeper borrowing costs and slower economic growth, a situation that tends to favour more defensive sectors, like staples, because their growth is more predictable.

History bears this out. Between 1994 and 1995, when the U.S. Federal Reserve raised its key rate from 3 per cent to 6 per cent, consumer staples were the third-best performing group among the 10 subindexes within the S&P 500. They rose 10.3 per cent, about 10 percentage points more than the benchmark index and about 20 percentage points higher than losing consumer discretionary stocks.

Between 2004 and 2006, when the Fed jacked up rates from 1 per cent to 5.25 per cent, the results are a little murkier. Consumer staples beat consumer discretionary stocks, rising 6.1 per cent, but lagged the S&P 500. However, this lag was because energy and materials stocks dominated the index as investors scrambled to join the commodities bull market (especially in oil).

When the Fed starts raising rates, perhaps late this year or early next year, consumer staples could again look attractive. They come with a big advantage: Relative to most other areas of the market, they are cheap and undiscovered.

Disclosure: No positions