By Jacob Sonenshine

Consumer staples stocks have taken off. It's now time to sell.

The Consumer Staples Select Sector SPDR exchange-traded fund, home to names such as Procter & Gamble, Colgate-Palmolive, Walmart, Coca-Cola, and PepsiCo, is up almost 8% from a multiweek low in early August, and it's outperformed the S&P 500 by 5.9 percentage points over the past three months.

It's not hard to see why. Investors want the safety of staples, whose sales and earnings don't take much of a hit when consumer spending slows down and when there are concerns about the health of the economy. And right now there are lots of concerns about the economy. The number of jobs added each month has declined, while growth in several sectors has slowed down. True, the Federal Reserve will likely cut interest rates this month to keep growth alive, but the positive economic impact won't be felt very soon.

But sometimes that fear can push demand for staples too far. This week, the Consumer Staples ETF rose to a level that was 10.6% above its 200-day moving average, a level it hit on just two other occasions since 2013, not including those that occurred within a week of each other. In both previous cases, staples went on to drop more than 5% over the following few weeks. Some long-term investors may find such a mild short-term drop acceptable, but it isn't ideal, and staples are still likely to underperform for a while.

Those price concerns are backed up by fundamentals. For one, large staples companies don't offer much profit growth. They're mature and have grown into the markets they operate in. Even when economic growth accelerates, consumers aren't significantly ramping up the rate at which they buy household items, groceries, and toothpaste. So when staples stocks reach a certain valuation, there just isn't enough growth to justify the price investors have to pay. Instead, they were bought because investors were scared, not betting on the future, and the stocks will pay the price when that fear dissipates.

Nor are the dividends offered by staples enough to justify the move. At current levels, the 12-month forward dividend yield for the Staples ETF is 2.5%, below the 3.6% yield offered by the ultrasafe 10-year Treasury bond. Of course, staples dividends will grow, likely at a rate of 7% for the next two years, according to analyst estimates on FactSet. If dividends grow at that rate for the next decade, the average annual yield for the fund would still be only 3.8%, according to Barron's calculations, not much additional return over bonds despite the higher risk.

"It's not an opportunistic time to buy them here," says Ellen Hazen, chief market strategist at F.L. Putnam Investment Management, of staples stocks.

Sure, investors who have ridden the gains and collected the dividends could sit tight, but there's a strong case to sell and look for more attractive opportunities.

If you can find them.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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September 13, 2024 21:30 ET (01:30 GMT)

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