The trend in demographics that caused the consumer discretionary sector to outperform the market average is set to do the same for the consumer staples sector. The rise in discretionary spending was fueled by the disposable income of Generation Y. The peak age on Generation Y's bell curve is currently 23. The ideal place to position investment is eight to ten years ahead of the peak of the curve. Demand accelerates in an expanding market as the peak approaches. Themes created by the large size of Generation Y create trends that investors can anticipate.
Households are established by couples in their mid-20s. The heavy spending needed to form and maintain home life is in place by the time the demographic reaches age 28. The spending done by a household is qualitatively different than the spending done by singles. Spending on essentials takes precedence over discretionary spending. Disposable income is reduced. Non-negotiable spending is prioritized. The shift in spending which is required to run a house is made.
Consumer staples are a defensive sector of the market. The relative stability of earnings makes the sector a haven in market downturns. This is relevant in today's market which will soon face two headwinds. The first headwind is reduced demand for stock as an investment vehicle from the diminutive Generation X. The Baby Boomer Generation, currently between the ages of 50 and 69, no longer has any more new members to enter the period of retirement saving that begins at age 50. The second headwind is reductions in Quantitative Easing, the program that has boosted share prices by providing inexpensive capital to companies that are well-positioned to repay the loans.
Investors will be watching liquidity-driven stocks during the upcoming weeks for signs of a top in the market. Momentum stocks like Tesla (NASDAQ:TSLA) and Netflix (NASDAQ:NFLX) have significantly outperformed the market. The outperformance indicates that investors are willing to give these stocks, and other momentum stocks, a higher multiple than the market average because of their unique business models. A reversal of sentiment will be shown when the momentum stocks top out or begin to decline. It will indicate investors think there are no longer some stocks that are much more attractive than others. A top in momentum stocks will indicate a change in sentiment from bullish to bearish. [The idea that correlation among stocks indicates shifting investor sentiment was taken from a recent Barron's article by Steven Sears, author of the column "Striking Price"].
Shares do not have to be overvalued for stock prices to fall. The current price-to-earnings multiple on the S&P 500 is 17, which is not much above the historical average of 15. This is higher than the multiple of 12 which occurred in the recession. Still, a price-to-earnings multiple of 17 does not indicate that the market will decline because it is overvalued. Despite strength in the economy from the demand of Generation Y, reduced demand for investment from the generation which followed the Boomer Generation is the central issue. The demographic which fuels the economy (Generation Y) is an entirely different demographic than the one which drove stock prices. Stock prices are now to be driven by Generation X, which is 11% smaller than the Boomer Generation. [The idea that, with the exception of the tech bubble, stocks have not been overvalued at the onset of a recession was taken from a recent Barron's article by Brendan Conway, author of the column "ETF Focus"].
An exchange-traded fund for consumer staples that caught my eye was First Trust Consumer Staples AlphaDex (NYSEARCA:FXG). It is the third-largest consumer staples ETF on the market today with $857 million in assets. The fund has an annual expense ratio of 0.7%, which is higher than the other large ETFs in the sector. The fund also has a greater spread than the other large ETFs, so the cost of buying is higher. FXG has a multifactor selection process which is designed to exclude underperforming stocks from the index it tracks. A method is then used to weight the holdings equally.
FXG has a strong tilt toward midcaps, which are considered to be more risky than large-caps. It has a focus on food stocks and other subsectors of the consumer staples industry. The other large consumer staple funds have performed in line with the market average year-to-date but FXG has outperformed the segment by at least 10 points. [Research was provided courtesy of Yahoo! Finance. "Consumer Staples Play: VDC or FXG?" by Cinthia Murphy on November 8, 2013].
The prominence of midcaps in the fund--as opposed to Coca-Cola (NYSE:KO), Philip Morris (NYSE:PM) and Wal-Mart (NYSE:WMT)--is a positive because of the lack of brand loyalty among members of Generation Y. Their taste runs more to niche items and they value a wide selection when shopping. Another positive for FXG is that, according to the ETFchannel at Forbes.com, the underlying holdings of the fund have experienced insider buying within the past six months. On a weighted basis, 12.4% of holdings have experienced the recent insider buying.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.