2023-10-03 13:30:00 ET
Summary
- The Consumer Staples sector has significantly underperformed the S&P 500 during 2023. This, combined with the possibility of recession, may lead to compelling value in this sector.
- In this article, I begin by offering an overview of the Consumer Staples sector in general, both in terms of advantages as well as drawbacks.
- From there, I dive into two quality ETFs in the space. In the end, I pick what I consider to be the winner between the two.
(This article was co-produced with Hoya Capital Real Estate.)
September was a rough month for the markets. After hitting recent highs right around the end of July, major market indexes declined by roughly 6.5 - 8.0% over the next two months.
Due to the Fed's continued actions, and the resulting increase in interest rates, bonds performed just as badly. In fact, long-dated bonds fell even more dramatically than did stocks.
Are there any sectors, then, that may offer compelling value at this point, particularly for investors who value sleeping well at night? In my search, I came across one sector that may be worth a closer look. This sector is Consumer Staples, sometimes also referred to as Consumer Defensive.
Would you like to see what I mean? Take a look at the below graphic. It lists YTD results for the two ETFs I will feature in today's article; Consumer Staples Select Sector SPDR Fund ETF (XLP) and Vanguard Consumer Staples ETF (VDC). As a benchmark, I chose Vanguard S&P 500 ETF (VOO), my favorite ETF to use as a proxy for the S&P 500. Please note that this comparison lists total return (including dividends) as opposed to simply price.
Perhaps you are familiar with the fact that what has sometimes been referred to as the 'Magnificent Seven' stocks have contributed almost 65% of all 2023 YTD market returns . As can be seen in the above graphic, stocks comprising the Consumer Staples sector have been among those left behind.
Before we get into a comparison of our two featured ETFs, let's take a look at some of the characteristics that may make this sector particularly attractive at this time.
Consumer Staples - Advantages
Solid performance during periods of recession - While they may vary with respect to their scope or depth, virtually all serious forecasts I have reviewed in recent weeks suggest that a strong likelihood of recession is yet ahead of us.
During such times, consumer staples have value as a defensive play. I have sometimes used the expression "you gotta eat" to refer to this sector. With that in mind, take a look at the sub sectors, or industries, into which this sector is commonly broken down:
- Beverages
- Food and staples retailing
- Food products
- Household products
- Personal products
- Tobacco
In short, this sector encompasses everything from the cereal you eat at breakfast to the toothpaste you use to brush your teeth at night, along with the beverages you drink during the day as well as the products you use to clean the floors of your home. It also encompasses the retail outlets at which you purchase such staples.
To get some idea of relative performance during the 2007-2009 recessionary period, take a look at the below backtest from Portfolio Visualizer . Please note that, for this comparison, I was unable to use VOO, due to its inception date of 9/7/2010, so I used SPDR S&P 500 ETF (SPY) instead.
Consumer Staples vs. S&P 500: 2007-2009 Recession (PortfolioVisualizer.com)
As can be seen, the consumer staples sector held up extraordinarily well during this period, as compared against the overall S&P 500.
Strong and consistent dividend income - Consumer staples stocks tend to pay solid dividends, and be able to do so in both good times and bad.
Here, from the same backtest referenced above, is the level of dividend income provided during the 2007-2009 recession.
XLP vs. VDC vs. SPY: 2007-2009 Dividend Income (PortfolioVisualizer.com)
Stability and longevity - We'll get into the specific companies comprising the Top 10 holdings of our 2 ETFs in the next section. When you see them, suffice it to say that you will recognize them as companies that have not only survived but prospered over decades, if not a century or more.
Consumer Staples - Drawbacks
In terms of minuses, here is the other side of the coin.
Lower Margins and Slower Growth - Given the fact that these products may be considered to be commodities and, in general, not subject to huge innovations and breakthroughs, profit margins tend to be less than in high-growth sectors. As a result, during periods of strong economic growth, they may underperform such dynamic and exciting sectors.
Potential Disruption - On the products side, you may have noticed that several large retailers now have 'house brands' to compete with products from established players, typically at lower prices. In turn, the retailers themselves are subject to online competition as the world continues to change.
Inflation - Ironically, consumer staples stocks can be negatively impacted during periods of high inflation. This is due to the fact that higher input and supply chain costs can eat into operating margins. Interestingly, at this point in time, it may be the case that such underperformance is already priced in , and that this sector may benefit to an outsized extent if inflation is tamed.
XLP Vs. VDC - Digging Into Two Worthy Contenders
Let's now take a quick look at two excellent ETFs that are the subject of this review.
Before we get into any differences, let's talk about the things the two ETFs share in common. First of all, they both have an excellent long-term track record with XLP, with an inception date of 12/16/1998, going back to the very earliest days of ETFs and VDC following roughly 5 years later, with an inception date of 1/26/2004. Secondly, they both sport huge AUM, with XLP coming in at $16.151 billion and VDC at $6.9 billion, according to their respective provider websites. Finally, they both carry the same expense ratio of .10%. In each of the 3 metrics, these are wonderful numbers for a sector fund.
The main difference is in the scope of the field from which XLP and VDC draw their constituents. In the case of XLP, as with all Select Sector indexes from SSGA (State Street Global Advisors), the starting point is the S&P 500 index.
In the case of VDC, the index tracked is the MSCI US Investable Market Consumer Staples 25/50 Index . This index is comprised of stocks of large, mid-size, and small U.S. companies within the consumer staples sector.
As a result, whereas XLP includes only large-cap stocks, VDC takes a broader approach, also including mid- and small-cap stocks.
Let's see how all of this plays out in two nice graphics from each ETF's respective landing page here on Seeking Alpha.
First, for XLP.
XLP: Top 10 Holdings & Dividend Characteristics (Seeking Alpha)
And next, for VDC .
VDC: Top 10 Holdings & Dividend Characteristics (Seeking Alpha)
Based on the above graphics, let's talk about just a couple of things that jumped out at me.
First of all, with only 38 holdings, XLP is a more focused fund than VDC, which contains 105 holdings as of this writing. If you look at the overall weightings in the Top 10 holdings of each ETF, you see this playing out. As an example, Procter & Gamble ( PG ) is the largest holding in each fund, but carries a weighting of 14.59% in XLP vs. 12.61% in VDC. Check out PepsiCo ( PEP ) as a second example of this.
I did notice, however, one fairly significant difference in the Top 10 list for the two funds, and it is with respect to Coca-Cola ( KO ). For whatever reason, KO has dropped to a 4.45% weighting in XLP while remaining at 8.24% in VDC. I tried to see if I could come up with an explanation as to why this is the case, but came up empty.
I wanted to confirm this so, as a double check, I headed over to ETF Research Center to check out the fund overlap.
The first thing I would like to feature is that all 38 holdings in XLP are also in VDC. As mentioned above, the typical pattern is that the weighting of most of these is slightly higher in XLP, as can be seen here.
XLP vs. VDC: Top 5 Holdings Overlap (ETF Research Center)
In the next screen, however, we see that disparity in Coca-Cola confirmed. Notice the 3.6% underweight in XLP as compared to VDC. On the left side of the picture, you will see the various overweightings on the XLP side that make up the difference.
XLP vs. VDC: Weighting Comparisons (ETF Research Center)
For those who may be unfamiliar with the concept of checking overlap between two funds, basically it is just a way of verifying that you stay properly diversified over the totality of the funds you select. In this case, for example, if you wish to take a position in the Consumer Staples sector, you don't need to buy both XLP and VDC. You can, but you aren't really gaining any meaningful benefit from doing so.
And that brings us to the last section. If you have to pick one, do I have a recommendation for you? As it happens, I do!
Performance - And Picking A Winner
To help you make a decision, take a look at the results of a backtest I ran, courtesy of Portfolio Visualizer. It's a simple comparison of the two ETFs, covering the period starting in January, 2005, through the present. You might notice that I also included the S&P 500 as a benchmark for evaluation.
XLP vs. VDC: 2005-2023 Backtest (PortfolioVisualizer.com)
Over this period of time, I would have to say that VDC appears to be the winner . Its slightly more inclusive stock selection filter, which includes exposure to mid- and small-cap stocks, has returned slightly better overall results with roughly the same volatility.
Here's perhaps the biggest surprise of all. In terms of risk-adjusted performance, both ETFs outperformed the S&P 500 over this roughly 18-year stretch! Quite a revelation, given we are talking about what is generally considered to be a defensive sector.
In summary, then, either ETF is a solid candidate for taking a defensive posture as we remain focused on the possibility of a recession in the near future. Of the two, I give a slight edge to VDC.
For further details see:
XLP Vs. VDC: 2 Compelling Choices For SWAN Investors