As the Federal Reserve signals a pause on raising rates, investors are starting to sell their positions in consumer staples stocks, one of the most popular defensive sectors of 2018. Meanwhile, other riskier sectors such as financial, industrials, energy and discretionary groups have regained favor and staged comebacks in January, all rising 8.9% or higher. (see table below.)

Mahoney Asset Management, for example, has reduced its holdings of consumer stocks such as Molson Coors Brewing Co. (TAP), Tyson Foods Inc. (TSN) and J.M. Smucker Co. (SJM), after buying them as part of a defensive strategy in the fourth quarter. Shifting consumer habits and rising costs have also hurt the sector, leading to disappointing earnings at firms including McCormick & Co. Inc. (MKC), Colgate-Palmolive Co. (CL) and Kimberly-Clark Corp. (KMB). “When the market is in full risk-on mode like it is so far this year, you don’t expect this sector to be the shining star or the darling of your portfolio,” says Scott Snyder, portfolio manager at ICON Advisers, which has roughly $1.5 billion in assets under management, per a detailed story in the Wall Street Journal.

Consumer Staples Trails Risk-On Rivals 

(Performance YTD)

  • Industrials; 10.9%
  • Energy; 10.2%
  • Consumer Discretionary; 9%
  • Financials; 8.9%
  • Consumer Staples; 3.1%
  • S&P 500; 7%

Source: S&P Dow Jones Indices

Safety Loses Its Luster

After outperforming in 2018, the market’s worst year in a decade, consumer staples are underperforming in 2019, adding just 3.1% YTD versus the S&P 500’s 7% return. Investors tend to treat consumer staples as a safe haven, given the nature of the products that they sell, with sales remaining relatively stable amid market and economic downturns. Additionally, the staples sector boasts a dividend yield around 3.1%, above the S&P 500’s 2% yield and the 2.7% yield on the 10-year U.S. Treasury note.

Earnings Weakness, Pricey Valuations

The consumer staples sector is expected to post its worst fourth-quarter earnings growth of the 11 sectors in the S&P 500, per the Journal. With about one-third of companies having reported as of Wednesday, earnings are projected to grow by a modest 3.6%. Disappointing profits have reignited concerns that traditional consumer staples firms have been slow to keep up with evolving consumer preferences. Other investors cite valuation as another weakness. Consumer staples stocks trade at around 18 times trailing earnings versus 16 times for the S&P 500. 

Looking Ahead

While the Fed has created a more "risk on" environment for the stock market, many negative headwinds remain, such as the China-U.S. trade war, Brexit, rising labor costs and inflation. Given this myriad of risks, it’s unlikely that investors will completely abandon defensive stocks. In fact, consumer staples could be set for another rally if the broader market faces a major setback.