Looking For Safety? Consumer Staples Have Provided It by Eric Bush, CFA – Gavekal Capital Blog
Let’s begin with the strongest current case against consumer staple stocks: they are expensive! Regardless of the valuation metric one picks, DM consumer staple stocks are trading near, at or above 2000 and 2007 levels. From a theoretical standpoint, the fact that consumer staple stocks are so expensive is counter-intuitive given that we have had historically low interest rates over the past several years in the US and around the developed world. With a backdrop like that, one would have thought cyclicals would be ripping higher and testing new valuation highs. Instead boring, old consumer staples is the sector testing historic levels. Sure, consumer staples provide a healthy dividend yield of 2.64% (amazingly equal to the 30-year treasury yield). But if anything that dividend yield is at the low-end of the trading range it has been in since 2010. So we don’t believe that the recent increase in valuation multiples can be completely explained by investors reaching for yield. Instead, we think consumer staples have been bid up thanks to the relative safety they provide to investors compared to other sectors in the equity market.
In this post, we are broadly definr safety in slightly different way. Instead of thinking of safety from a max drawdown perspective, we are going to look at it from the percentage of stocks that are in a bear market (down 20%) over the previous 200-days. Because if fewer stocks are in a bear market, that increases an investors chance that an individual stock from that sector or the sector as a whole will outperform. Outside of the financial crisis (because everything cratered during the financial crisis), consumer staples have managed to have had the fewest percentage of stocks fall into a bear market since 2004. Consumer staples have even managed to have a lower percentage of stocks fall into a bear than the usual defensive stalwarts telecom and utilities. Let’s go through some charts to see what we mean.
Outside of the financial crisis, the highest percentage of stocks to be in a bear market for over the previous 200-days for consumer staples was on 5/26/2010. 35% of consumer staples stocks were in a bear market on that day. From 2004-2006, only once did more than 20% of stocks fall into a bear market. And since 2010, most selloffs coincided with between 25-30% of stocks falling into a bear market. A decently high number for sure, but as you will see it is far below the other sectors.
Let’s look at the other extreme next and see what the most “unsafe” sector, energy, looks like. Currently, even with the rally in 2016, 30% of energy stocks are still down over 20%. This is a vast improvement compared to 1/26/2016 when 94% of energy stocks were in a bear market! There have been roughly 10 times, not including the financial crisis, since 2004 when at least 60% of energy stocks were in a bear market. Remember, there wasn’t one period other than in the financial crisis, when consumer staples was within 20% of that level.
Before moving on to what is usually considered the most defensive, or safest sector, let’s see how technology stocks have done since 2004. Technology stocks have surpassed the 60% threshold four times (again not including the financial crisis) since 2004. And on average since 2004, 30% of technology stocks are in a bear market. The average percentage of consumer staples stocks in a bear market is only 15%.
Finally lets compare how consumer staples have done compared to utility stocks. Prior to the financial crisis, utilities were safer than consumer staple stocks. The largest percentage of stocks in a bear market from 2004-2006 was just 10%. However, since the financial crisis volatility has spiked in the utilities sector. There have been four different occasions when at least 40% of utilities were in a bear market. This is a percentage level that consumer staple stocks have not once reached during this period. So even in this low rate enviroment when utiltilty stocks are offering over a dividend yield that is 100+ bps more than what consumer staple stocks offer, consumer staples have been safer than utility stocks.