By Shashwat Chauhan
March 13 (Reuters) – After a strong rally this year, U.S. consumer staples stocks are falling out of favor, with investors starting to question the high valuation as earnings prospects dim, analysts said.
Staples, widely considered as safe havens within equities, became a popular refuge earlier this year when investors fled highly valued technology stocks on concerns about heavy artificial intelligence-led investments and the technology’s disruptive effects on businesses.
The sharp rotation helped push the S&P 500 consumer staples index’s forward price-to-earnings (PE) ratio – a widely watched valuation metric, to its highest since June 1999, as per LSEG data.
However, cracks have started to appear since the index hit a record high in mid-February.
The group has shed 5.6% so far in March, with technology and energy shares regaining momentum after the Middle East conflict broke out on February 28. Investors typically move into defensive sectors during periods of geopolitical uncertainty, seeking steady earnings regardless of the economic backdrop.
“Rising inflation expectations tied to potential escalation with Iran could begin to undermine the defensive appeal of staples, particularly given how strongly the sector has already performed this year,” said Neil Wilson, investor strategist at Saxo.
Analysts fear that broad inflationary pressures, fueled by the Iran war, could squeeze consumer spending and hurt earnings growth in the sector. Food companies, which constitute a chunk of the staples index, are already facing the threat of changing eating habits due to the increasing popularity of weight-loss drugs.
First-quarter earnings for the S&P 500 consumer staples sector are expected to rise 1.9%, compared with 6.6% growth seen at the start of the year, according to Tajinder Dhillon, head of earnings and equity research at LSEG.
Meanwhile, the benchmark S&P 500 is expected to record earnings growth of 12.8% in the current quarter.
But even before the U.S. and Israel war on Iran started, Cheerios cereal maker General Mills cut its annual core sales and profit forecasts, sparking a selloff across food companies last month. More recently, pretzel maker Campbell’s Co cut its forecast and suspended its share buyback plans, citing weak demand for its snacks.
They are among the worst performing staples stocks this year, with Campbell’s shares trading at their lowest since March 2003.
“We want to be selective in this environment, focused on earnings growth, as further multiple expansion (is) unlikely,” said Jake Johnston, deputy CIO of Advisors Asset Management.
On the other hand, a broader move into defensive stocks earlier this year and positive quarterly results from big-box retailers Costco Wholesale and Walmart have helped their shares record double-digit gains this year.
“A consequence of the rally is that the two largest stocks in the index are overvalued,” said Mark Preskett, senior portfolio manager at Morningstar Wealth.
Costco and Walmart’s stocks are trading at more than 40 times their forward earnings, and have the highest valuations in the sector.
“Walmart’s latest results were excellent. However, it is still overvalued in our eyes, and investors are clearly paying a lot for the perceived resilience of earnings,” Preskett said.
Despite recent declines, the sector is still up 10% year-to-date, and not everyone thinks it will be a downhill, especially if AI worries return to the fore.
“In this period now where we are living through so much AI-related uncertainty, including around its potential impact on which companies survive and broader employment, staples have a benefit in investors’ minds because they are not in AI’s path of destruction,” said Erika Maschmeyer, portfolio manager at Columbia Threadneedle.
(Reporting by Shashwat Chauhan in Bengaluru; writing by Sruthi Shankar; Editing by Shinjini Ganguli)
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