5 Consumer Staples Stocks For An Era Of Soft Yields

The Fed’s decidedly dovish turn on interest rates last week has pushed government bond yields to their lowest point in more than a year. A section of economists believe global economic weakness has played a role in lowering yields. But the consensus is clear; an economic slowdown is around the corner. And it would be prudent for investors to seek defensive stocks.

When it comes to safer equity categories, consumer staples have a clear edge. The stability and superior dividends that they provide are common to most other defensive options. Also, Deutsche Bank (NYSE:DB) thinks they are yet to price in low rates, unlike real estate investment trusts (REITs) and utilities. This is why it makes sense to add consumer staples stocks to your portfolios at this time.

10-Year Treasury Yield Plumbs Fresh 14-Month Low

On Mar 27, the plunge in long-term treasury yields continued unabated. The yield on the 10-year Treasury note had touched 2.38% by 5:17 PM ET, its lowest since December 2017. Ultimately, the yield lost 2 basis points to finish the day at 2.39%. The 30-year Treasury bond yield lost 3 basis points to close at 2.83%.

Additionally, the 3-month Treasury bond yield lost 2 basis points to close the day at 2.44%. Worryingly, the yield on the 10-year Treasury note has lost 20 basis points since Mar 15.

In fact, the retreat in yields is now a worldwide phenomenon. This is because central banks are opting to keep interest rates lower for a period which is much longer than what was being predicted even a year ago.

Concerns about tepid growth have troubled China and most of Europe for some time now. But, as was apparent last week, sluggish inflation was enough for the Fed to revise its monetary stance drastically.

Defensive Stocks Gain Popularity, Consumer Staples Hold Edge

According to Larry McDonald, founder of The Bear Traps Report, it is increasingly apparent that investors are beginning to rotate out of cyclicals, like financials. The beneficiaries of such a movement have been defensive stocks like consumer staples.

McDonald points out that the path of the Financial Select Sector SPDR Fund (XLF) and the Consumer Staples Select Sector SPDR (XLP) has begun to diverge recently. While the XLP is up 2.1% since Mar 1, the XLF has lost 4.2% over the same period.

This divergence is essentially a product of soft rates, which are likely to remain low for most of the year. In fact, there is currently a 70% chance that the Fed will cut rates at least once by Dec 11. Trump’s pick for the central bank Stephen Moore thinks the Fed should “cut rates by half a percentage point” immediately.

In such circumstances, consumer staples companies emerge as a logical choice for most investors, according to Binky Chadha, chief strategist at Deutsche Bank. This is because they are yet to price in a decline in rates, unlike other defensive options such as REITs and utilities.

Chadha thinks consumer staples are still priced for a substantially higher yield, close to 3%. This means that they will retain upside “even if rates and growth stay at current levels, more so if they decline further.”

Our Choices

With the Fed likely to maintain a dovish stance going ahead, interest rates are likely to remain low for an extended period. The fact that long-term rates are declining faster than their short term counterparts also indicates that at the very least, an economic slowdown is around the corner.

In such circumstances, defensive options become the natural choice for most investors. Consumer staples companies hold the edge here, since they are yet to price in a fall in rates, per Deutsche Bank. However, picking winning stocks may be difficult.

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Written By: Zacks Investment Research