Consumer Staples Sector Rating: Neutral
The sector underperformed as the economy recovered from the COVID-19 pandemic, as would be expected for a traditionally defensive sector whose constituents are typically less affected by changes in the business cycle. However, a peak in the rate of economic growth and the associated potential for higher market volatility could weigh on cyclical sectors, boosting the relative attractiveness of the more defensive and larger-cap stocks within the Consumer Staples sector. On balance, we think the macroeconomic impact on the sector is improving relative to the other sectors.
Many of sector’s valuations measures are still above their historical averages, as is the case for nearly all the other sectors. But in relative terms, the Consumer Staples sector falls in the middle of the pack—neither relatively attractive nor expensive. The ongoing rise in transportation and commodity costs have weighed on earnings, but many of the companies in the Consumer Staples sector have been able to pass some of those higher costs on to consumers. And the reopening of restaurants is boosting wholesale food demand, which portends an improvement in fundamentals—particularly if companies can maintain prices at higher levels as input costs presumably ease in the coming months. However, it has not yet been seen if pricing power can be maintained amid stiff competition within the sector. For now, this leaves our fundamental view at neutral, as well.
The Russian invasion of Ukraine in late February, and the ongoing political response, has clouded our outlook on equity sectors. Due to the unprecedented and volatile series of events, the economic and market landscape has become highly uncertain.
Until there is more clarity on how the sharp rise in commodity prices, tightening of financial conditions, and likely Federal Reserve interest rate hikes might impact the economy and underlying fundamentals that drive relative sector performance, we think it’s prudent to maintain sector allocations that are in line with the overall market.
Positives for the sector:
• It typically has a stable earnings profile
• Companies have engaged in aggressive cost-cutting
• Restaurant openings are supporting wholesale food demand
• Companies have been successful in passing along higher costs.
Negatives for the sector:
• This defensive sector typically struggles during periods of economic growth—but signs of a peak in the rate of growth and increased potential for higher volatility could make it more attractive to investors
• Many companies in this sector are facing higher input costs, though they are having success in raising prices.
Risks for the sector:
• The sector could perform better than expected if inflationary pressures enable significantly more pricing power (this is an upside risk)
• A rise in interest rates combined with stronger-than-expected economic growth could result in underperformance
• Risks to the economy—such as the COVID-19 delta variant, or aggressive rate hikes by the Federal Reserve amid rising inflation concerns—could support this defensive sector more than is currently expected (again, this is an upside risk)
What do the ratings mean?
The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:
- Outperform: likely to perform better than the broader stock market*
- Underperform: likely to perform worse than the broader stock market*
- Neutral: no current view on likely relative performance
* As represented by the S&P 500 index
Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare. Clients can log in to see our top-rated stocks in the Consumer Staples sector.
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