This week in the podcast, we dig into Consumer Staples, the third best performing sector in the S&P 500 so far in 2022. The big thing you need to know: We are sticking with a market weight stance on the sector. The tailwinds that have boosted sector performance so far this year (a favorable macro backdrop for defensives, rising recession fears, strong money flows, and a higher quality profile than other defensives) may continue to support leadership in the sector in the near-term. But our list of concerns on the sector is growing, and includes extremely problematic valuations, crowded positioning, earnings revisions risk, a weaker ESG profile, and a cautious outlook from our analyst team. On a 6-12 month view, we think staying neutral makes the most sense and we’re reluctant to chase.
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winds for the sector in early:
- First, a favorable macro backdrop for defensives generally. Defensive sectors as a group (Consumer Staples, Utilities, Health Care) tend to outperform both Cyclicals and Secular Growth oriented sectors following first Fed rates hikes (an important milestone that has recently passed),
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has gotten underway in early:
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o and when ISM manufacturing is falling (a trend that got underway last year). On this last point it’s worth noting that relative to all other major sectors, Consumer Staples shows the greatest tendency to outperform when ISM manufacturing is in a downtrend.
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dership we’ve seen in early:
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rom strong ETF flows in early:
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stors to flock to it in early:
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med for good reasons in early:
• First, extremely expensive valuations. The P/E of the sector relative to the S&P 500 was 1.6 standard deviations above the long-term average at the end of April, before taking a hit in May. April’s high was admittedly a little bit below past peaks (which tended to be seen around major equity market lows), but were still quite stretched nonetheless.
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o With the hit the sector took in mid-May around retail earnings, Staples is no longer the most expensive sector in the S&P 500. But it’s still high on the list, coming in behind only Utilities and Health Care.
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o Defensive sectors generally look overvalued to us right now, particularly relative to Secular Growth-oriented sectors, with relative valuations between the two baskets near historical extremes, which are often seen around major equity market lows.
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n the industrial recession of:
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- Third, earnings revision trends that may be at risk. Consumer Staples has been weak on earnings revisions for quite some time with more negative than positive revisions to sell-side EPS forecasts. However, the sector has still been seeing positive revenue revisions, driven by strong underlying demand as well as pricing and inflation. While the rate of upward earnings revision trends fell to levels that were close to historical lows in April, we see a risk that they get stuck in deeply negative territory if revenue revisions falter as the consumer comes under pressure and potentially pushes back on pricing.
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• Fourth, a less favorable ESG profile. Analysis from our ESG Strategist, Sara Mahaffy, suggests that Consumer Staples has a less appealing ESG profile than most other S&P 500 sectors. Her works shows that global sustainable funds have been underweight Consumer Staples, with low aggregate ESG momentum scores.
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• Fifth, a less favorable view of the outlook for the sector from our analyst team. Our US equity analysts’ outlooks are an important contributing factor to our equity strategy sector recommendations. In our latest quarterly RBC analyst survey, our Consumer Staples team (led by Nik Modi) stood out for being the least constructive on performance. Recent conversations with our Consumer Staples team and other analyst teams across the department suggests that this remains the case today. In our survey, it was noteworthy that our Consumer Staples team had some of the deepest concerns about direct and indirect exposure to the Russia/Ukraine conflict relative to analysts in other sectors. In their recent publications, they have also argued that it will be harder for their companies to get through pricing as retailers fight to keep foot traffic as the consumer comes under further inflationary pressure and savings rates dwindle.
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ed Consumer Staples so far in:
Wrapping up with one final thought - with a possible inflection in the broader market underway, we think a market weight stance on Consumer Staples makes sense for investors with a 6-12 month time frame. We are also mindful of the possibility that if the equity market isn’t bottoming, it will most likely be due to signs that consumers broadly are breaking down, which will pose yet another fundamental headwind for consumer stocks generally.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for thoughts on specific sectors from RBC’s team of industry analysts.
