Trying Times For Staples ETFs

The Consumer Staples Select Sect. SPDR (ETF) XLP is up about 1.8 percent this week. Perhaps that is the beginning of a comeback for a once hot sector exchange-traded fund that now resides about 7.5 percent below its July highs.

Low Beta Sectors' Recent Performance

Earlier this year, low beta sectors were leading broader benchmarks higher. And part of the reason defensive groups such as consumer staples and utilities were performing well also is that these sectors are interest rate-sensitive, meaning the Federal Reserve's refusal to raise interest rates this year was giving investors good reason to embrace higher-yielding, lower beta sectors.

As has been the case with the once beloved utilities sector, much of the allure surrounding consumer staples stocks, XLP and rival staples is evaporating as markets price in increasing chances of the Fed raising interest rates in December.

Near-Term Interest Rate Outlook

The near-term interest rate outlook, the one that includes Fed funds' futures pricing in a roughly 95 percent chance that the Federal Reserve hikes rates next week, could be one reason some analysts are have tepid views on XLP. For example, AltaVista Research has a Neutral rating on the largest staples ETF.

That rating “indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category,” said AltaVista in a recent note.

The Fed's monetary policy presents other risks to staples ETFs such as XLP. Notably, a stronger U.S. dollar often accompanies rising Treasury yields, which is problematic for multi-national companies that derive substantial portions of their sales overseas. That description fits many of XLP's 39 holdings.

XLP, Holdings And Consumer Staples

Marquee holdings in XLP include Dow components Procter & Gamble Co PG and The Coca-Cola Co KO, two companies that generate substantial portions of their sales in markets outside the United States.

“Consumer Staples tumbled post-election as the possibility of higher interest rates makes the sector's dividend payouts somewhat less attractive in comparison. The decline brought the P/E ratio to its lowest level in two years, but that was only enough for an upgrade from Underweight to Neutral [emphasis omitted] territory. Return on Equity looks headed in the wrong direction, and forecasts for 2017 look overly optimistic to us in light of recent history,” said AltaVista.

Investors have pulled capital from some staples ETFs this year. For example, the First Trust Cnsumer Stapl Alpha Fd (ETF) FXG, a smart beta rival to XLP, has bled more than $2.1 billion, a total exceed by just nine other ETFs. XLP has lost $349.1 million in assets this year.