While the market as a whole has been strong since the election, we are also in what appears to be a gasping-for-air rally, which for all intents and purposes is almost eight years old. While stocks can go higher, some out there may be thinking the time has come to shift assets to sectors that are more conservative as they tend to perform better when the going gets tough.
One of those sectors is consumer staples, and while the logic to own shares is that we all have to buy the necessities that go with day-to-day living, there are also reasons to avoid the sector. When those reasons come from Savita Subramanian, who is one of the outstanding Equity and Quant Strategists at Merrill Lynch, we tend to take a closer look.
While the sector has lagged the overall market since the election, it has outperformed for the last six weeks. Given what happened to Target after releasing very poor results and guidance, it makes sense to check out Subramanian’s 10 reasons to avoid shares and stay underweight the consumer staples sector.
1. Price-to-earnings (P/E) multiples have expanded with very little earnings per share (EPS) growth. The sector multiple has risen more than any other on lesser earnings growth.
2. Weak fundamentals: Sales and earnings are below average, and analysts around Wall Street are cutting estimates. They also note that EPS growth from cost-cutting looks maxed out.
3. Staples are not the sector to own when S&P 500 profits as a whole are growing, and Merrill Lynch sees them growing in 2017.
4. The sector is also negatively correlated to inflation at all levels. That includes consumer prices, producer prices, commodity prices and wages.
5. The sector is also negatively correlated to rising interest rates as it serves as a bond proxy sector when rates are artificially low like they have been for years. And rates are going higher.
6. Ditto a stronger dollar: Consumer staples is the most foreign-exposed defensive sector. While it has historically outperformed during periods of a stronger dollar, the correlation is weak, and it recently turned negative. Plus, the sector has big exposure to emerging markets, where higher rates and a strengthening dollar can hurt.
7. The border adjustment tax could subtract as much as 11% from 2018 EPS estimates. That’s the largest for any sector except energy. While the proposed tax is not a certainty, even without it the sector is still middle of the pack.
8. Staples is the highest quality sector in the S&P 500, and while Merrill Lynch likes high-quality stocks, they are currently lagging lower quality and that could remain in place.
9. The sector benefited from large inflows into low-volatility fund strategies. The low-beta bubble is deflating, according to the analysts, and outflows from these funds have increased. Of course outflows means selling.
10. Merrill Lynch usually takes a medium-term horizon on sector calls, but the team also makes the case that short-term investors may also want to avoid the sector.
Subramanian and the Event and Quant team are among the best on Wall Street, and it makes sense for all the reasons listed above for investors to underweight the sector. It doesn’t mean sell everything immediately, but it does suggest moving to areas where the opportunity is better now.