VDC And XLP: Staples Crushed Growth And Technology Over 21 Years

Summary

• Growth loses to value, we show you one longer-term case study.
• The staples sector is perfect for this as it is about the hardest one to get excited about, growth wise.
• We use two sector ETFs and tell you which one we would choose if we had to.
• I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Juanmonino/iStock Unreleased via Getty Images

Cycles. We have them in the laundry room and we have them in biochemistry. We also have them in the market. Unfortunately, people forget that. Consider this article as a reminder. In this one we are going to do a few things. First, we will discuss what is a good way to measure performance of a sector or fund. Second, we will go over two staples sector ETFs and tell you how the staples sector crushed the Nasdaq 100 (referred to further as the growth sector) since March 2000. Third, we will tell you why this is happening again today and finally we tell you why the protagonist should be considered for that victory.

Performance Measuring

Returns are best appreciated over a full cycle. This allows a full course of market evaluation and also allows time for plenty of fads to draw money from the last sucker before going to zero. There are other reasons as well. Some sectors are stronger in up markets while others more defiant when the tides turn. Assessing in just one aspect, such as during the latest bull market, leaves the investor vulnerable to recency bias.

This full cycle return assessment should be done either peak to peak or trough to trough. That is take returns from one peak to the next or from one trough to the next. One can of course do both. Here, it is important to not get too tied down in the minutiae. General broader market peaks as represented by S&P 500 (SPY) works well for this, even though individual sectors peak a little before or after. If there is a difference, you will see it without a need to massage the data.

Staples ETFs & Staples Crushing Growth

Vanguard Consumer Staples ETF (NYSEARCA:VDC) is an ultralow expense fund with fees of just 10 basis points and a 5-star rating from Morning Star. The fund is top heavy and the top 10 make up a huge chunk of the ETF.

Source: Vanguard

Despite being top heavy, the fund carries 99 holdings.

Source: Vanguard

This is one reason we are going to gravitate towards VDC, even though we will use another very similar ETF to run some comparisons.

The Consumer Staples Select Sector SPDR ETF (NYSEARCA:XLP) is very similar to VDC and a cursory glance at the top 10 holdings might give you Deja Vu.

Source: XLP

But the fund only has 32 total holdings and here is where we think VDC has a slight edge.

Data by YCharts

We can see above how closely XLP and VDC have tracked each other since the latter came into existence. With that visual in mind, we can use XLP data as it predates VDC, for the purposes of this exercise. Let us now get on with the task of showing how staples crushed the Invesco Nasdaq 100 ETF (QQQ), aka growth.

In the first cycle, XLP beat QQQ by a resounding 100%.

Data by YCharts

Note that we are starting here from the exact Nasdaq peak to the October 2007 peak before the global financial crisis.

The second cycle, XLP got slammed with QQQ generating a big advantage.

Data by YCharts

One deceptive aspect of that chart is that it does not show you the full impact of the previous cycle underperformance. You cannot just add up percentages over two cycles. Over the last 21 years, staples have left QQQ so far behind, even after this monstrous challenge of every valuation metric, that it is not funny.

Data by YCharts

Why Did This Happen?

Money is made in bear markets and not in bull markets. When you lose the least, you make it very hard for the other sector/fund to catch up. You can see above that QQQ has been trying really hard. We have multiple stocks trading at valuations that one could not have fathomed, ever. Yet, the ETF has no chance of overcoming this gap. Note that we compared XLP to QQQ above as a proxy for growth. If we look at Technology Select Sector SPDR (XLK) the results are even better for XLP.

Data by YCharts

If we use Ryan Jacob's Internet Fund, the hottest growth fund of the Nasdaq bubble phase, as the growth proxy, you better sit down before you look at the results.

Data by YCharts

What Does The Next Cycle Look Like?

Investors heady from the recent gains in growth indices might argue "yeah but, you did not look at the last cycle before the internet." While we don't claim to have looked at every possible statistic that exists, there are some broad brush strokes that one can recognize. For example, information technology is generally a bad sector over very long periods. Note that this one goes back to 1974.

Source: Kailash Capital

Technology is inherently deflationary and price competition always wins, especially when investors are ready to finance growth despite losses.

The next cycle is likely to be very similar to what we saw from the Nasdaq in 2000. Certainly, valuations look right in the ballpark.

Source: Kailash Capital-2

The staples sector continues to be hated. Consumer Staples to Consumer Discretionary Sector (XLY) ratio is much lower than even what we saw at the Dot Com bubble peak.

Data by YCharts

The only question remains is when will this turn. As we have seen, currently only the generals are holding the frontlines and they are likely to fall soon.

Conclusion

VDC has lower fees than XLP and is less concentrated, giving you 99 holdings instead of just 32. Either fund though, is fine to invest for the next decade as the growth bubble fully implodes and everyone slowly gets with the "last time was not different" bandwagon. We prefer individual trades, but are finding more to like in the consumer staples and healthcare sectors than most others today.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

We have some long positions on Staples Sector ETF components and some short positions on QQQ components.

Comments

[Bob Bailey]

I worked in the consumer goods area for 37 years. The companies have done well on a long term basis. What caused many of them to grow from the fall of the Soviet Union until the Great Recession was global expansion. That is largely gone and the companies don’t have any other large source of growth. For the past decade many of them have been low growth to no growth businesses. For this sector past performance is not prologue for what’s coming. They are likely to get price increases reflecting inflation and not much more.

[psioni]

@Bob Bailey You make a good point about globalization. I wonder if it has really run its course. China, SE Asia, India and Africa all are expected to have large growing population with middle class income. Another source of growth for some of these companies is premiumization; for example Diageo refocusing on premium spirits, or Unilever selling off low margin brands and balancing more towards premium high margin ones.

[ExIRguy]

Great analysis, thanks for this article. One ETF I like in this space is RHS, an equal weighted consumer staples ETF. Fees are higher, but over the past 10 years and over its full lifetime it has outperformed VDC and XLP.

[Trapping Value]

@ExIRguy Thanks for reading and the idea!

[dbm_stuff]

Expense ratios do not matter do they as return are Net of Expenses?

[FognFriction]

Really interesting analysis - thanks!

[Breadth and Sentiment]

Be careful of anything that is looking backward. Demographics and household formation going forward are the opposite of the last 70 years.

[Baloney Sandwitch]

Good insight. I think this is another low volatility factor investing. Low volatility stocks (like staples) tend to outperform over long periods of time if you are a buy and hold investor. Tech is high vol (with long cycles).

[Trapping Value]

@Baloney Sandwitch Yes great point. Thanks for reading and commenting.

[Pippy54]

I like your contrary thinking. I also like the comment below about the risk of margin compression. Interesting setup.

[FROGBERT]

I'm on the other side of the staples trade having recently rung the register on PG, MDLZ & KHC at significant gains. My thesis is that rising costs will squeeze margins and branding won't be strong enough to prevent margin compression. The valuations on these was very full so no room for multiple expansion in rising rate environment. These are good co's and if they sell off to the point of being good values, I'll buy them back.

[Trapping Value]

@FROGBERT I agree that is a risk. It is hard to blend my bullish views on commodities with consumer staples picks but they tend to be great portfolio stabilizers when you get the inevitable sharp selloff in commodities. You have to pick the ones that are modestly valued and have some semblance of pricing power. As long as we do that, margin pressure is not the end of the world.

[Kenmare]

Very stimulating piece, TV. Many thanks. Would you care to share a few of your favorite individual issues in Staples we might consider?

[Trapping Value]

@Kenmare Thanks for reading.
One to consider would be ConAgra Brands. Also there is picture up for you for a second choice :)