Trade tensions may dent defensive armor of consumer staples stocks

June 6, 2019

By April Joyner

NEW YORK (Reuters) – Shares of consumer staples companies are commonly seen as a safe harbor among U.S. equities but may be more susceptible to the fallout from tensions between the United States and its trading partners than other defensive sectors such as utilities and real estate.

Persistent trade disputes could raise the cost of goods for consumer staples companies and squeeze their margins, which would hamper their performance in the months to come, market watchers say. U.S. tariffs have also weighed on China’s economy and could have a similar impact on other targeted countries, which would hurt the performance of companies that sell to those countries.

Stocks dived in May after U.S. President Donald Trump stated he intended to hike tariffs on goods from China. Those increases, to 25% from 10% on $200 billion worth of Chinese goods, went into effect on Saturday.

The S&P 500 has risen some 2.8% so far in June as expectations that the Federal Reserve will cut interest rates have for the moment superseded trade worries.

But Trump has also vowed to levy import taxes on goods from Mexico in an attempt to pressure Mexican authorities to stem illegal immigration into the United States, though Mexico has held talks with the United States in an effort to avoid such tariffs.

Over the past month, investors have turned to less risky assets such as U.S. government bonds. Among stocks, utilities, real estate and consumer staples shares, which are considered bond proxies because of their high dividend yields, outperformed the S&P 500, which fell 6.6% in May.

According to a Reuters analysis based on data from Yardeni Research, consumer staples outperformed the S&P 500 in four of the five times since 2009 that the benchmark index has dropped more than 10% and led performance among bond proxies once.

But they have lagged utilities and real estate recently. Among the bond proxy group in May, the S&P 500 real estate index eked out a 0.05% gain, and the S&P 500 utilities index fell 0.6%, both holding up better than the S&P 500 consumer staples index, which dropped 3.5%.

“Because trade and tariffs are starting to heat up again, there’s not as much of a safe-haven in consumer staples as much as something like utilities,” said Shawn Cruz, manager of trader strategy at TD Ameritrade in Jersey City, New Jersey. “You can get some benefit in being more selective among defensive sectors.”

Oliver Pursche, chief market strategist at Bruderman Asset Management in New York, recently revised his allocation of consumer staples shares to underweight from overweight. He has maintained overweight exposure to utilities.

“Their margins are so thin already, so when they get hit with tariffs, it becomes exponentially more problematic,” he said of consumer staples companies.

Campbell Soup Co has said tariffs on Mexican goods would raise its costs, and such levies are also expected to have a significant impact on Constellation Brands Inc and Brown-Forman Corp, which import beer and tequila, respectively, from Mexico.

It’s not just a matter of costs. Eleven U.S.-listed consumer staples companies – including Mondelez International Inc and Philip Morris International Inc – are estimated to generate at least a tenth of their sales in China, and six companies in the sector are estimated to get at least 5 percent of their sales in Mexico. The utilities and real estate sectors, which are domestically focused, lack such exposure.

Indeed, though Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets in New York, has an “overweight” rating for consumer staples, in her view the sector has high risk exposure to a potential trade conflict with Mexico and moderate exposure to the trade war with China.

“The trade war disadvantages them a little bit, compared to utilities and real estate,” she said.

The sector has long faced profit margin pressures, said Rob Almeida, global investment strategist at MFS Investment Management in Boston, and an escalated global trade conflict would only exacerbate that issue. If trade conflicts were to weigh on the U.S. economy, the sector’s rising leverage ratios could also pose trouble, in his view.

“It’s a sector more leveraged than normal, and it has more risk of margin decay, and those are issues it’s had in the past,” he said.

To be sure, some strategists find advantages in consumer staples. Emily Roland, head of capital markets research at John Hancock Investments in Boston, favors the sector as a defensive play based upon its return on equity and 12-month forward price-to-earnings ratio.

“From a valuation standpoint, it’s reasonable,” she said. “Utilities and REITs have become more expensive.”

Even those who favor consumer staples shares, however, acknowledge that as long as trade tensions remain prominent among investors’ concerns, the sector’s defensive properties are likely to be tested.

“We’re starting to run out of places to hide,” RBC’s Calvasina said. “Almost every sector has some political issues out there.”

(Reporting by April Joyner; Editing by Alden Bentley and Nick Zieminski)

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