What’s exciting about toothpaste, soap, laundry detergent and toilet paper? You might be surprised.
Often perceived as boring, the consumer staples sector is broader than many investors think, and has experienced some interesting developments in recent years, according to Brad Sorensen, managing director of market and sector analysis for the Schwab Center for Financial Research.
Traditionally, consumer staples—which includes makers of food, beverage and tobacco products, non-durable household goods and personal products, supermarkets and drug stores—has been considered a “defensive” sector for investors. That means it tends to do relatively well compared with other sectors when the economy is slowing, because in general consumers will continue to buy items like food and cleaning products regardless of the state of the economy. On the other hand, when the economy is strengthening, other sectors tend to be more attractive to investors than consumer staples.
However, Brad believes the consumer staples sector may perform relatively well even if the economy and stock market continues to be strong.
“Portions of the sector have taken a beating recently, which we think is a bit overdone,” Brad says.
For instance, food retailer stocks declined after internet-based retailer Amazon announced its takeover of grocery and health food store Whole Foods Market earlier this year. The merger, announced in June, was completed in August. Investors grew nervous that already thin margins in the grocery space would collapse further as more shopping potentially moved online, Brad says.
But Brad says he doesn’t think traditional grocers are going away. “They are used to fighting for every dollar, and are going to do so in this case as well,” Brad says. “We’ve already seen some major mergers in the space in recent years, such as Tyson Foods and Hillshire Brands, Kraft and Heinz, and British Tobacco with Reynolds America. We think this trend will continue as companies look to economies of scale to better compete on price and get an even tighter rein on costs.”
Innovation exists even in “boring” industries like food products, tobacco and beverages, Brad says.
“Just think of how many options you encounter when looking at those areas,” he says. “And for the older ones among us, how much those products and services have changed over the past 50, 30, or even 20 years.”
Additionally, even a “defensive” sector can benefit from the improving economy and tighter labor market, Brad says. For example, confident consumers may upgrade their laundry detergent or throw a few extra items in the grocery cart that normally they might not buy.
Nevertheless, investors shouldn’t read this as a reason to overweight their portfolio toward consumer staples stocks, Brad says. It remains true the staples sector historically has performed relatively better when the economy is weakening, and so far, the economy has continued to show signs of steady growth.
“We don’t believe the economy will deteriorate in the near future, which is why we’re not advocating loading up on the group,” Brad says. “But defensiveness can be an important part of a portfolio.”
In other words, an appropriate allocation to defensive sectors such as consumer staples can help to diversify a portfolio, potentially helping an investor weather an unexpected market downturn with less volatility than he or she might otherwise experience.
“In the past, the sector has tended to go up about half as much as the S&P 500® Index when there are gains, but also tended to lose about half as much when there is a market downturn,” Brad says. “Of course, that’s based on historical performance, and is no guarantee of what will occur in the future.”