Consumer-staple stocks, typically known for their stability, have experienced a significant decline in 2023. Despite this drop, these stocks are not yet considered cheap enough for bargain hunters.
2022 was a positive year for consumer staples, as their reputation for safety benefited them during the market downturn. However, this year has been a different story. The market's risk-driven rally in 2023 has reduced investors' interest in stable consumer stocks. Even the dominant Big Tech sector has taken the mantle of being a defensive safe haven during recent banking concerns.
Furthermore, higher interest rates have diminished the appeal of these stocks' attractive dividends. There is also concern among investors that weight-loss drugs may cause a long-term decrease in demand for food and beverages. Additionally, brands are currently experiencing a natural decline in demand after the pandemic-induced surge in sales when everyone was staying at home.
Consequently, while the S&P 500 has risen by approximately 13% year-to-date, the Consumer Staples Select Sector SPDR exchange-traded fund (ticker: XLP) has fallen by roughly 9%. Despite this decline, the valuations of these stocks are not particularly enticing, making it challenging to invest in the sector except for a few select names.
As a result, consumer staples find themselves in a state of limbo, with uncertainty surrounding factors that could improve their prospects in the near future. Wells Fargo analyst Chris Carey refers to this situation as a shift from a "staple-topia" to a "staple-dystopia."
According to Carey, "After having the best performance relative to the market in a generation in 2022, entering 2023 was always going to be challenging. However, the intensity of the recent decline has been remarkable due to factors such as rates, volume, and GLP-1. The problem is that we are unlikely to see the necessary fundamental changes to drive improvement in the third quarter with regards to volumes, and while valuations are better, they are not remarkably cheap."
Carey highlights that exchange rates continue to pose a problem for multinational companies, and higher prices are still impacting consumer demand. Inflation-weary consumers are naturally reducing their spending.
Additionally, while concerns about Ozempic have caused some investors to shift towards home and personal-care stocks instead of food and beverages, the valuations of these alternative stocks have become relatively higher.
The Great Reset in Staples
Challenging Times for Staples
The term "great reset" perfectly captures the current state of staples, as coined by Carey. While 2022 was a remarkable year for staples compared to the market, things have taken a downturn. Staples are underperforming the market this year, heading towards their worst performance in at least two decades, even worse than the setback experienced in 2003.
Mounting Pressures on Consumers
Filippo Falorni from Citi Research expresses concern over mounting pressures on consumers in the US. Inflation, rising interest rates, and the resumption of student loan repayments contribute to these challenges. For consumer staples companies, the situation is compounded by a stronger US dollar, increasing oil prices, and higher borrowing costs.
Mixed Reports during Earnings Season
While we are yet to witness the full swing of the third-quarter earnings season, consumer-staples reports have been mixed so far. The outlook remains uncertain, and investors may have to weather some negativity before seeing brighter days.
Navigating the Market
Ivan Holman, an analyst at Bernstein, believes that concerns surrounding weight-loss drugs may be exaggerated. However, he acknowledges that the market can often behave irrationally for extended periods of time. In light of this uncertainty, he suggests there is no need to jump in and be a hero.
Contrarian Winners in the Sector
Despite the challenges, there are still some potential winners in the sector. Carey highlights Church & Dwight (CHD) and Procter & Gamble (PG) as companies with fundamental strength and compelling narratives. These two seem to be moving in the right direction while others are still grappling with the normalization of their fundamentals.
Furthermore, Carey believes Keurig Dr Pepper stock (KDP) has been undervalued considering the improvements in its coffee business and the ongoing momentum in cold beverages.
All three companies - Church & Dwight (CHD), Procter & Gamble (PG), and Keurig Dr Pepper (KDP) - will be reporting their results in the coming weeks. So, get ready to grab some popcorn and stay tuned.