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Summary

  • Change in Sector leadership and U.S. 10 Year Treasury yield declines are suggesting a pullback in U.S. equities.
  • Investors can defend their portfolio by taking an overweight position in the Consumer Staples Select Sector SPDR ETF.
  • Investors should take an underweight position in Avon Products.

Getting Defensive with Consumer Staples - The Spartan Shield

The Spartan Army was one of the most feared armies in world history. The soldiers carried several weapons such as the Dory, the Spartan sword or Xiphos, the Kopis and the Hoplite shield or Aspis (also known as the 'Hoplon'). The shield was undoubtedly the most important protective device in the Greek warrior's panoply, however, Spartans also used it to bash their opponents. Enemies were stunned, knocked down or pushed back with the Aspis, in order to allow the Spartan to use another weapon.

As the U.S. equity markets face all-time highs there appears to be signs of weakness and room for a pullback. Leadership in certain sectors in the S&P 500 Index and U.S. 10-year Treasury yield performance appear to confirm these signals. Thus, U.S. equity portfolios should be protected from attacks due to downside moves and one shield to do so is the Consumer Staples sector. Access to this sector can be attained through the Consumer Staples Select Sector SPDR ETF (NYSEARCA:XLP). However, an underweight position should be taken on one of the equity positions in XLP, Avon Products (NYSE:AVP), as the stock has been lagging its peers within the ETF XLP and has been facing several challenges.

DEFENSES UP

Spartan investors should prepare for a wave of selling as two arrows were shot across the equity market war field, Consumer Staples sector leadership and U.S. Treasury yield performance. The table below shows the 1-month, 3-month, 6-month, 9-month and 1-year sector leaders and laggards of the S&P 500 Index as at April 30th 2014.

Table 1 Periodic Sector Returns as at April 30th 2014

Sector

1-Mth (%)

3-Mth (%)

6Mth (%)

9-Mth (%)

1-Yr (%)

S&P 500 CONS DISCRET IDX

-1.41

1.53

10.94

14

16.99

S&P 500 CONS STAPLES IDX

2.70

8.28

11.7

10.08

7.45

S&P 500 ENERGY INDEX

5.11

12.43

15.37

16.15

18.56

S&P 500 FINANCIALS INDEX

-1.64

4.37

13.24

10.99

17.51

S&P 500 HEALTH CARE IDX

-0.60

3.87

18.31

21.04

22.74

S&P 500 INDUSTRIALS IDX

1.50

5.89

20.41

21.84

27.47

S&P 500 INFO TECH INDEX

0.21

4.78

18.34

17.64

22.61

S&P 500 MATERIALS INDEX

0.69

8.05

18.08

18.74

20.71

S&P 500 TELECOM SERV IDX

0.43

4.02

3.19

0.02

-7.42

S&P 500 UTILITIES INDEX

4.20

10.42

16.48

15.37

4.32

Source: Bloomberg

The sector leaders and laggards were identified as follows:

Table 2 Periodic Sector Leaders and Laggards

1-Mth Top 3 Leaders

1-Mth Top 3 Laggards

Energy

Health Care

Utilities

Cons. Dis.

Cons. Staples

Financials

3-Mth Top 3 Leaders

3-Mth Top 3 Laggards

Energy

Cons. Dis.

Utilities

Health Care

Cons. Staples

Telecom

6-Mth Top 3 Leaders

6-Mth Top 3 Laggards

Industrials

Telecom

Info Tech

Cons. Dis.

Health Care

Cons. Staples

9-Mth Top 3 Leaders

9-Mth Top 3 Laggards

Industrials

Telecom

Health Care

Cons. Staples

Materials

Financials

1-Yr Top 3 Leaders

1-Yr Top 3 Laggards

Industrials

Telecom

Health Care

Utilities

Info Tech

Cons. Staples

Investors can identify the shift from the cyclical Industrial and Information Technology sectors to the topping Energy sector as well as the defensive Consumer Staples & Utilities Sectors. Leadership in the Energy sector suggests that economic expansion is nearing completion as high oil prices threaten economic growth.

Chart 1 U.S. 10 Year Yield as at 23rd May 2014

Source: Bloomberg

Recent price action in the U.S. 10-year Treasury yield suggests some level of weakness in the U.S. equity markets. After making a high of 3.0516% on January 2nd 2014, the U.S. 10-year yield Index formed a flag formation setup. The setup indicates that the U.S. 10-year can fall to a yield of approximately 2.30%. The declines are on the backdrop of a reduction in asset purchases by the Fed as well as rising inflation data. The Fed stated:

Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of U.S.$20 Bn per month rather than U.S.$25 Bn per month and will add to its holdings of longer-term Treasury securities at a pace of U.S.$25 Bn per month rather than the U.S.$30 Bn per month.

The latest data also shows that in April, the cost of living had the largest margin of growth in almost a year. U.S. CPI rose 0.5% year-over-year in April 2014 to 2.0%. The chart below shows U.S. CPI.

Chart 2 U.S. CPI (%) YoY May-08 to May-14

Source: Bloomberg

The declining yields, despite recent rising inflation information, suggest that investors are choosing to be defensive in their asset allocation.

WHY USE A SPARTAN SHIELD

Investors require solid protection as they face the downside risks of the U.S. equity markets. This guard is XLP.

Chart 3 XLP BETA May-08 to May-14

Source: Bloomberg

XLP has a weekly adjusted beta of 0.688 versus the S&P 500 Index (NYSEARCA:SPY). This means that it is positively correlated with the market but only moves 0.688% as much as the S&P 500 Index. Thus, if the S&P 500 Index were to increase by 1%, it is expected that XLP would also increase, but by approximately 0.688%. Conversely, if the S&P 500 Index were to decline by 1%, then XLP should also fall, but by 0.688%, which would mitigate downside shocks in a Spartan investor's equity portfolio.

Since the consumer staples sector is also a sector leader, it is expected that out of all the equity sectors, the consumer staples sector should decline the least, further protecting the portfolio, in the event of a decline of the overall equity market. The 'bashing' of the Spartan shield is seen through its dividend and earnings yield. XLP has a 12-month dividend yield of 2.38%, 0.55% higher than the SPY's 1.83% 12-month dividend yield. XLP also has an earnings yield potential of 5.1%, surpassing most U.S. investment grade fixed income instruments, including the U.S. 10-year treasury yield of 2.53%.

CHINKS IN THE ARMOR

XLP was dissected to see the leaders and laggards over various periods. The table below displays the results.

Table 3 Periodic Sector Leaders and Laggards of

1-Mth Top 3 Leaders

1-Mth Top 3 Laggards

Lorillard Inc (NYSE:LO)

Keurig Green Mountain Inc (NASDAQ:GMCR)

Estee Lauder Cos Inc (NYSE:EL)

Hershey Co (NYSE:HSY)

Altria Group (NYSE:MO)

Constellation Brands Inc (NYSE:STZ)

3-Mth Top 3 Leaders

3-Mth Top 3 Laggards

Kroger Co (NYSE:KR)

Whole Foods Market Inc (NASDAQ:WFM)

Safeway Inc (NYSE:SWY)

ConAgra Foods Inc (NYSE:CAG)

Lorillard Inc

Hershey Co

6-Mth Top 3 Leaders

6-Mth Top 3 Laggards

Tyson Foods Inc (NYSE:TSN)

Whole Foods Market Inc

Keurig Green Mountain Inc

JM Smucker Co (NYSE:SJM)

Brown-Forman Corp (NYSE:BF.B)

Avon Products

9-Mth Top 3 Leaders

9-Mth Top 3 Laggards

Constellation Brands Inc

Avon Products

Tyson Foods Inc

ConAgra Foods Inc

Safeway Inc

JM Smucker Co

1-Yr Top 3 Leaders

1-Yr Top 3 Laggards

Tyson Foods Inc

Avon Products

Safeway Inc

ConAgra Foods Inc

Keurig Green Mountain Inc

Philip Morris International Inc (NYSE:PM)

From the table, Avon Products was identified as a laggard because it was the only security that was a top laggard in 3 or more time periods (6-month, 9-month and 12-month). Also upon further investigation its lagging performance reflected its fundamentals and technicals. This security should have an underweight position in an equity portfolio. The table below gives some metrics on the security.

Table 4 Avon Products Metrics

Metrics

Value

Current P/E

35.80

3-Year Average Quarterly P/E

19.19

5-Year Average Quarterly P/E

18.26

Q1 Mar-14 Revenue Growth

-11.1%

12 Months Ending Mar-14 Gross Margin

60.70%

12 Months Ending Mar-14 EBITDA

-3.9Mn

Q1 Mar-14 Net Income Before XO

-167.20Mn

Q1 Mar-14 Net Income Before XO Margin

-7.7%

Q1 Mar-14 Adjusted EPS

0.12

Mar-14 Adjusted EPS Growth

-53.8%

Free Cash Flow

-142.2Mn

Dividend Yield

1.70%

Here are some highlights:

  • Experienced depressed sales in 3 of 4 regions.
  • Gross and net operating margins are down meaningfully.
  • Given 45.7% of revenue is generated in Latin America and 27.7% of revenue is generated in Europe, the Middle East and Africa, face unfavorable movement in foreign exchange rates and higher than expected cost pressures as the U.S. Dollar strengthens.
  • Relatively lackluster economic growth in some developed markets, particularly in Europe should limit overall revenue gains and profits. Sales growth in the Asia region has also slowed.
  • AVP is in a downtrend, with recent resistance at the continuation gap around the $15 price level. Estimates are for the security to continue its downward trajectory around the $13.20 price level, a multi-year low.

Chart 4 Avon Products as at May 23rd 2014

SHIELDING YOUR PORTFOLIO

XLP can be used to defend a portfolio from declines in U.S. equity markets as Consumer Staples tend to lead during market sell-offs and the dividend yield tends to cushion declines. Thus, Spartan investors should consider an overweight position in XLP. Furthermore investors should dig deeper and analyze the stocks within the ETF, so they can decipher whether they should overweight or underweight these companies in their portfolio, as seen in AVP above.

Source: Getting Defensive With Consumer Staples - The Spartan Shield