JONATHAN LEVIN AND ANDREA FELSTED: Defensive stocks are paying off — but it gets trickier from here
Staples stocks have outperformed their consumer discretionary peers by the widest margin in two decades
The threat of US stagflation has investors treating supermarkets and other consumer staples companies like the high-flying tech stocks of yesteryear. The shares have trounced their consumer discretionary peers by the widest margin in two decades, and the outperformance probably has room to continue.
The reason is understandable given the economic backdrop. Investors are afraid of the effect slower growth will probably have on discretionary spending and equally petrified of what inflation at 40-year highs means for fixed income and cash. Many have settled for a strategy centred on defensive stocks — which include utilities and health care in addition to household products — and it has panned out so far.
Staples have been stars. The broadest index of S&P 500 consumer staples stocks has advanced 12% in the past 100 trading days, while discretionary shares have declined 18%.
In a recession, staples usually retrench eventually, just not as much as other sectors. But most doomsayers think a US recession — if one comes — is more likely to occur in 2023 or 2024. Staples powered through roughly the first half of the Great Recession before fading eventually.
Of course, not all staples are created equal, and their differences may become increasingly important as concerns mount that the Federal Reserve’s fight against inflation could tip the economy into recession. The wealthy will keep spending on high-end goods. But average earners may well trade down, particularly as more price increases crop up for everyday items. Procter & Gamble, Nestlé and Unilever have warned of more increases in the coming months.
One tried-and-tested mechanism to cope with inflation is to trade down from more expensive household names to supermarkets’ cheaper private-label products.
This has not shown up much in first-quarter earnings, though Unilever, whose brands include Dove soap and Ben & Jerry’s ice-cream, did see a fall in the amount of goods. But private-label sales are starting to gain traction, according to data provider IRI. If this trend gathers momentum, it could eventually cut the sales volume of Nestlé’s Nespresso coffee capsules or P&G’s Pampers nappies.
While that may be a concern for the big manufacturers, supermarkets known for their cheap prices, such as Walmart, Costco and Target, could be beneficiaries. Other winners include the US arms of German discounters Aldi and Lidl, which are expanding across the US. They are part of Germany’s Schwarz Group.
Dollar General and Dollar Tree not only carry inexpensive wares, but their pricing schemes aid consumers on a budget. They also look a lot more like supermarkets these days than simply cheap retailers, with a broad line of food. The digital couponing trend on TikTok — essentially influencers showing consumers how to combine coupons for big savings — is also driving free advertising.
As investors favour staples, it has become popular to dump stocks exposed to lower-income consumers because they spend a higher proportion of their incomes on food and fuel. Consequently, the thesis goes, they will be disproportionately affected by rising prices.
But this misses a key point. While some shoppers at discount chains will have to pull in the purse strings, these retailers could benefit from higher-income consumers trading down. Any loss of sales from traditional customers should be offset by an influx of new shoppers. Walmart said in February that all consumers — even wealthier families — become more price sensitive during periods of inflation.
The biggest danger to investors therefore lies not in the bargain basement but the squeezed middle. Some signs of this are already playing out.
Clearly, some of Gap’s problems at Old Navy are of its own making — not having enough fashionable dresses and tops as shoppers rapidly pivot from cozy to chic, for example. Supply chain bottlenecks have not helped either.
But Old Navy is exactly the type of brand that is vulnerable to rivals such as Walmart and Associated British Foods’ Primark, which is opening more US stores and trading well in the region. Though Target’s prices are similar to Old Navy’s, its fashion is edgier, something that consumers are prioritising as they head out to restaurants and prepare for holidays.
TJX Companies, the owner of TJ Maxx and Marshalls, may be another beneficiary from stretched budgets.
Trading down could also favour Chipotle Mexican Grill, as Americans swap pricier takeouts or a meal at a fast casual restaurant for value fare. Though Chipotle has raised prices, it has seen little resistance from customers, perhaps because the increases were from a low base.
So while investors have got it right by favouring staples, the market is likely to get trickier from here; investors may need to get choosy. Companies that discount essentials may be one of the final refuges if the outlook worsens.
Bloomberg Opinion. For more articles like this please visit Bloomberg.com/opinion.
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