From Standard & Poor's Equity Research
How do key S&P 500 sectors stack up for 2008? Here is the first in a series examining the outlook for five S&P sectors: the four with marketweight recommendations that have the largest market cap weightings in the S&P 500 index—and the one sector with an overweight recommendation. A selection of five of S&P's top-ranked stocks in each sector will also be featured. Be sure to check back in the days to follow for more sectors—and stock picks.
Sector Recommendation: MARKETWEIGHT
S&P 500 Market Cap Weighting: 10.3%
S&P recommends market-weighting the S&P 500 Consumer Staples sector. Year to date through Nov. 23, this sector, which represented 10.3% of the S&P 500 index, was up 10.6%, compared with a 1.6% gain for the 500. In 2006 this sector index gained 11.8%, vs. a 13.6% rise for the S&P 500. There are 12 subindustry indexes in this sector, with household products being the largest, representing 23.3% of the sector's market value.
S&P analysts' fundamental outlook for the sector is neutral. More specifically, we remain neutral on the household products and packaged foods & meats subindustries, which together represent 36% of the sector's market capitalization. At a time when the U.S. economy is slowing, the sector's sizable 47% international revenue exposure—as estimated by S&P's Index Services group—is allowing it to leverage ongoing overseas expansions. Commodity pricing pressures are being offset by corporate restructurings, which are helping maintain margins, in our view.
The sector recently traded at a price-to-earnings (p-e) ratio on estimated 2008 earnings of 17.4, vs. 13.9 for the broader market. Its p-e to projected five-year earnings per share growth rate of 1.6 times is higher than the market's 1.1 times, reflecting above-average EPS growth predictability, in our opinion.
Our technical opinion on the S&P 500 Consumer Staples sector is positive. The index continues to drift higher within a moderately sloped, bullish channel, but is approaching the top of this channel, so upside could be limited. The index continues to be well-supported, in our view, as it has held key chart levels, as well as key moving averages over the past couple of years. Relative strength vs. the S&P 500 has broken sharply to the upside, after putting in a large double bottom in 2006 and 2007.
In summary, while the sector's dependable revenues and low beta (a measure of volatility) are notable in a slowing economic environment, we believe two factors will curtail its longer-term outperformance: 1) rising raw material costs and high valuations should make market outperformance unlikely; and 2) since we believe the S&P 500 will experience an 8% to 12% correction, and not a new bear market, investors may soon gravitate away from these defensive issues.
More information about S&P equity research can be found at http://outlook.standardandpoors.com.