A shelf life for consumer staples

As investors we have become captivated by the actions of the Federal Reserve and what that means for markets and investments decisions. However broader economic conditions beyond quantitative easing warrant thought.

Economically things are looking better – for the first time in three years, global GDP growth is decisively picking up. In conjunction with this, the threat of a catastrophic event derailing the global financial system has abated as European banks are no longer considered to pose a systematic threat to the global financial system, and this is helping reduce macro uncertainty.

The other reality weighing in on markets is the fact that when the Federal Reserve does eventually wind back quantitative easing interest rates will rise globally, disrupting the trend of sectors leveraged to interest rates. This will have varying impacts on individual sectors.

History suggests based on prevailing economic conditions and expectations, consumer staples as a sector are not in favour.

The three months ending in October have consumer staples coming in as a lagging sector, with gains of just 4.4 per cent against a lift of 7.4 per cent on the ASX 200. Over the same time we have seen the yield on the Australian 10-year government bond jump around, following leads from the US.

Over the past twelve months, rising bond yields (green line) have resulted in flat to falling share price performance of consumer staples (white line). On the other hand, falling bond yields have seen consumer staples gain convincingly.   

If the expectation and existing relationship holds that bond yields will in fact rise over the year ahead, consumer staples looks set to be negatively impact. Majors across the sector include both Wesfarmers and Woolworths, which are well run businesses, but in this instance broader macro-economic conditions can play a significant role in how these investments are traded in the market place.

Beyond trading expectations, Morgan Stanley, looking at valuations as a sector, has estimated the current 12-month forward price earnings ratio for consumer staples to be 17.8, which is a significant premium to the five-year average of 15.2. The premium can be explained in part by a solid price earnings expansion, which will now need to be supported with a commensurate increase in earnings.

For consumer staples, natural defensive characteristics mean the sector benefits when growth decelerates but doesn’t fare as well when growth changes direction.