Shocker: A Bullish Call on Staples ETFs

As vexing as it has been to plenty of experts and pundits, the rally in U.S. stocks has been one of the risk variety. Plain and simple, low volatility sectors have lead U.S. equities to record highs. The consumer staples sector has held a prominent leadership, not just in 2013, but dating back three years. A combination of decent dividend yields and investors' skittishness toward high-beta sectors have boosted returns to staples stocks and inflows to the corresponding ETFs. As S&P Capital points out in a new research note, "the Federal Reserve's monetary policy, which is keeping interest rates low, is pushing income-starved investors toward high quality dividend growers, such as those found in the Consumer Staples sector." Still, there are issues within the sector to consider. While earnings for the group are expected to outpace the S&P 500 this year, valuation in this low-beta group are looking frothy. "On a valuation basis, as of April 5, the group of larger Consumer Staples stocks was trading at 17.0X projected 2013 operating EPS, compared to a 14.1X P/E for the S&P 500," said S&P Capital IQ in the note. "The forward P/E multiple for both had expanded since early January (more so for the Consumer Staples group), although the pace of expended EPS growth in full-year 2013 had come down between one and three percentage points. "As of April 4, 2013, based on the Capital IQ consensus, first quarter 2013 operating EPS of large Consumer Staples companies were expected to be up 4.4%, compared to a 0.6% increase for the broader S&P 500 group. For all of 2013, Consumer Staples EPS was expected to rise 8.8%, following an estimated 5.4% increase in 2012. For all companies in the S&P 500, EPS was projected to rise 7.4% in 2013, following a 4.5% estimated increase in 2012." With those concerns in mind, S&P still has a favorable view of the staples group, including some of the sector's marquee names and ETFs, such as the Consumer Staples Select Sector SPDR XLP. XLP is the largest staples ETF with over $6.9 billion in assets under management and the second-cheapest with an expense ratio of 0.18 percent. XLP, which S&P rates Overweight, is up 16.2 percent year-to-date and his home to some of the individual names S&P is most bullish. Coca-Cola KO, Philip Morris PM and CVS Caremark CVS are three of XLP's top-five holdings and all three earn five-star ratings from S&P. XLP also allocates just under two percent of its combined weight to ConAgra CAG and J.M. Smucker SJM. S&P also five-star ratings on those names. XLP's chief rival is the Vanguard Consumer Staples ETF VDC. VDC is the cheapest staples ETF with a 0.14 percent annual fee and also earned an Overweight rating from S&P. Coca-Cola, Philip Morris and CVS Caremark are three of VDC's top-seven holdings, combing for 22.2 percent of the ETF's weight. VDC has matched XLP with a 16.2 percent year-to-date return, though the Vanguard offering has been slightly less volatile. S&P also has Overweight rating on the iShares Dow Jones U.S. Consumer Goods Sector Index Fund IYK. IYK is pricier than XLP and VDC with annual fees of 0.46 percent. Additionally, IYK is more of a staples/discretionary mix. The ETF does feature Coca-Cola and Philip Morris among its top-10 holdings, but Ford F and Nike NKE are found among that lineup as well. IYK is up 14.1 percent this year and has been slightly more volatile than its SPDR and Vanguard rivals. Investors looking for some global staples exposure can consider the Overweight-rated iShares S&P Global Consumer Staples Sector Index Fund KXI. Just under 51 percent of KXI's country weight goes to the U.S. followed by the U.K. at 14.4 percent and Switzerland at 7.6 percent. All of the Swiss exposure comes by virtue of Nestle NSRGY being the ETF's largest holding, KXI's other top-10 holdings include Coca-Cola, Philip Morris and Procter & Gamble PG. The ETF is up 13.7 percent, but does offer some potential should the aforementioned staples names boost international sales. "We expect emerging international markets to remain an important focus for growth, with the prospect that rising incomes and changing lifestyles will help to increase demand for the some of the types of packaged consumer products that are so prevalent and popular in the U.S. We think U.S. companies will be looking for acquisition and joint venture opportunities as a means of accelerating international growth," said S&P Capital IQ. For more on staples ETFs, click here.