Staples ETFs Confront A Potentially Hawkish Fed

Much is made of the impact of higher interest rates on various sectors. For example, conventional wisdom tells investors that financial services stocks often benefit from Federal Reserve tightening cycles while utilities stocks are laggards.

Historical data from various tightening cycles, indicate that while utilities do lag sometimes, the punishment is not usually severe. Conversely, financial stocks have disappointed in various eras of Fed tightening. Still, investors can react emotionally to the notion of higher rates and the subsequent impact on select sectors.

Utilities, Financials And Staples Amid Atmospheric Uncertainty

Hence, it might make sense that the Consumer Staples Select Sect. SPDR (ETF) XLP draws a tepid neutral rating from AltaVista Research. XLP, the largest staples exchange-traded fund, and rival staples ETFs are often seen as rate-sensitive almost on par with utilities stocks and ETFs.

With Treasury yields rising in anticipation of multiple rate hikes by the Federal Reserve this year, investors might do well to consider cyclical groups over defensive sectors, such as staples.

XLP's Neutral 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.

Other Issues

Another obvious issue confronting ETFs such as XLP is the stronger dollar. Although AltaVista forecast solid earnings per share growth for XLP this year, that thesis could be challenged by the rising greenback. Major XLP holdings, such as Procter & Gamble Co PG, PepsiCo, Inc. PEP and others derive significant portions of their sales overseas.

That is a potential knock on an ETF expected to sport a 2017 price-to-earnings ratio north of 19, while the P/E for the S&P 500 is expected to be just over 17, according to AltaVista data.

“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 2 years, but that was only enough for an upgrade from Underweight to NEUTRAL 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 $300.6 million from XLP this year.