Stock market bulls and bears agree on at least one thing. The highest valuations for makers of household goods since 2008 signal the best is over after the industry rose more than any other group this year.
Supermarket operators, food producers and soapmakers in the MSCI World (MXWO) Index gained 3.1 percent in 2011 through Oct. 14 as the gauge for developed-market stocks lost 7.3 percent on concern the global economy is slowing. Japan Tobacco Inc. (2914), the seller of Mild Seven cigarettes, trades 12 percent above its price-earnings multiple from the past five years. Hershey Co. (HSY)’s 27 percent rally pushed the chocolate maker to the biggest premium to profits since 2008, data compiled by Bloomberg show.
Bears say the easy money has been made in so-called defensive shares should the world slip into a recession. Bulls favor companies with faster earnings growth and cheaper valuations. The last time household-goods producers were this expensive versus the MSCI World, stocks were about to begin an advance in which bank, mining and industrial stocks jumped more than 137 percent, while consumer staples rose 76 percent.
“You’ve got too much money that has been bet that we’re going into a recession,” said Jeffrey Saut, who helps oversee $300 billion as chief investment strategist at Raymond James & Associates in St. Petersburg, Florida. “If we don’t go into a recession, you’ll get a whole rotation out of these highly valued defensive stocks into more aggressive stocks.”
Almost $9 trillion has been erased from the value of equities worldwide since May as Europe’s sovereign debt crisis worsened and U.S. unemployment stayed above 9 percent. The MSCI World plunged 17 percent between July and September, the biggest quarterly drop since the end of 2008, when credit markets froze after the collapse of Lehman Brothers Holdings Inc. in New York. The MSCI World Index fell 1.3 percent at 4:08 p.m. New York time while consumer-staples stocks in the measure dropped 0.9 percent.
Raymond James bought shares of Caterpillar Inc. (CAT), the world’s largest maker of construction and mining equipment, Saut said in an Oct. 12 telephone interview. The Peoria, Illinois- based company, which reports earnings on Oct. 24, has dropped 27 percent from an April peak and is valued at 13.5 times reported earnings, compared with 24.8 a year ago.
Stocks rallied last week, sending the MSCI World up 5.4 percent to a six-week high of 1,186.40, as European leaders took steps to contain the debt crisis and analysts’ estimates showed U.S. companies will report an eighth consecutive quarter of earnings growth. Coca-Cola Co., Johnson & Johnson and Apple Inc. are among the 101 Standard & Poor’s 500 Index companies scheduled to release results this week, according to data compiled by Bloomberg.
No industry will shield investors from losses when the decline resumes, according to Puru Saxena, who oversees about $250 million as chief executive officer of Puru Saxena Wealth Management. He predicted in December 2009, when gold averaged $1,129.70 an ounce, that prices would reach $2,000. Futures on the metal climbed to a record $1,923.70 on Sept. 6, 2011. His October 2010 forecast for a bull market in China was too optimistic. The MSCI China Index has lost 25 percent since then.
“We’re in an economic slowdown that could be quite significant,” Saxena said in a telephone interview from Hong Kong on Oct. 13. “In a big recession, all equities go down in value. It doesn’t matter what sector or country.”
He bought exchange-traded funds that move in the opposite direction of the S&P 500 and the Nasdaq-100 Index. Saxena forecasts a recession that may cut U.S. earnings by 15 to 20 percent and drive the S&P 500 to 750 from 1,224.58 last week.
While MSCI World consumer staples sank 25 percent in 2008, the most since data on the industry began in 1996, the decline was the second smallest among 10 groups. Energy shares collectively slumped 39 percent and financial shares plunged 56 percent that year as the global economy contracted for the first time since World War II.
Producers of household goods may boost per-share profit 9.5 percent next year, according to the average analyst estimate compiled by Bloomberg. Income for the MSCI World may increase 11 percent in 2012. The 18 companies in the global benchmark that have reported quarterly results since Oct. 11 have increased earnings by 11 percent, Bloomberg data show.
Manulife Asset Management (Japan) Ltd.’s Hidehiro Tomioka owns Japan Tobacco and Unicharm Corp. (8113), a Tokyo-based maker of toiletries. He’s betting the industry will benefit from sales to faster-growing Asian markets such as Indonesia, where gross domestic product may increase 6.6 percent next year, economists’ estimates tracked by Bloomberg show.
Japan Tobacco gained 23 percent in 2011 through last week on speculation it will operate with fewer constraints should the government sell its majority stake. The Tokyo-based company may raise its dividend payout target, Executive Deputy President Masakazu Shimizu said in an Oct. 12 interview. Its price- earnings ratio of 24.4 is the highest since March 2010.
“The fundamentals for this industry are quite strong,” Tomioka, who helps oversee $1.5 billion in Tokyo, said in an Oct. 13 phone interview. “The earnings have been stronger than the street expectation, and given that the market will likely muddle through the next few months, these shares are still good.”
Hershey has rallied 27 percent this year after cocoa prices sank to the lowest level since July 2009 amid record production in Ivory Coast and Ghana, the world’s largest growers. The Hershey, Pennsylvania-based candy maker trades at 22.6 times reported profit, compared with 12.7 for the MSCI World, data compiled by Bloomberg show.
‘Places to Hide’
“Consumer staples have been one of the better places to hide,” Tim Ghriskey, who oversees $2 billion as chief investment officer of Solaris Group LLC in Bedford Hills, New York, said in an Oct. 12 phone interview. “If the market reverses and continues to improve, this group will definitely be sold.”
The S&P 500 rallied 6 percent last week, the most since July 2009, compared with a 2.8 percent gain for consumer-staple shares in the index. The U.S. equity benchmark has lost 2.6 percent in 2011, the second-best performance among 24 developed markets after New Zealand.
Harry Rady, who manages $260 million as chief executive officer of La Jolla, California-based Rady Asset Management LLC, said shares of food producers are vulnerable because profits may shrink if commodities rise. The S&P GSCI Index of 24 raw materials rose 5.2 percent last week after wheat broke a six- week losing streak and corn gained the most since July.
“We’re looking at a number of short candidates in the sector,” Rady said in a telephone interview on Oct. 12. “Disappointment can come from many places and just a little bit of it can cause the prices to drop precipitously.”
Cargill Inc., the Minneapolis-based grain distributor that is the largest closely held company in the U.S., said on Oct. 10 that first-quarter profit from continuing operations fell 66 percent because of volatility in commodity markets. Purchase, New York-based PepsiCo Inc., the world’s biggest snack-food maker, rose 2 percent last week after beating profit estimates.
Producers of household goods have never been cheaper relative to their bonds. Profit for the S&P 500 Consumer Staples Index reached 6.80 percent of share prices this month, data compiled by Bloomberg show. That compares with a record-low yield of 2.48 percent for a Bank of America Corp. gauge of U.S. consumer company debt that dates back to 1996. The S&P 500’s earnings yield is 7.5 percent, close to the highest level since 2009.
Nestle SA (NESN), the world’s biggest food company, received the lowest rate on a European company loan in four years in September. The maker of Nescafe agreed to pay 10 basis points more than the euro interbank offered rate on a 4 billion euro ($5.55 billion) one-year revolving credit. The Vevey, Switzerland-based company has a price-earnings ratio of 19.4, versus the multiple of 11.2 for the Stoxx Europe 600 Index.
BNY Mellon Wealth Management’s New York-based Chief Investment Officer Leo Grohowski said his firm sold shares of tobacco and packaged-food companies last quarter and bought energy and technology stocks. Technology companies in the S&P 500 rallied 7.9 percent last week after falling as much as 17 percent between July and August. Energy producers advanced 8.8 percent, the most since January 2009, trimming the industry’s year-to-date loss to 1.7 percent.
“The consumer-staples group has really done what it’s supposed to do in a volatile market in attracting investors looking for defensive places to park their money,” Grohowski, whose firm oversees $171 billion, said in a telephone interview on Oct. 13. “It just got a little bit ahead of itself.”