Get Ready to Buy Consumer Staples
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On August 7 2012, the Dow Jones Industrial Average set a new 10-week high, with a gain of 1.2% in the past five days. This mini-rally occured largely due to improvement in manufacturing, construction and employment related indicators for the month of July (released in early August). Remember, in July's first week, the market started tanking because June's number for these very same indicators came out disappointing.
The market in the next couple of months will remain extremely sensitive to important economic indicators relating to housing, construction/industrial activity, consumer spending and employment. Some of these indicators have shown improvement in August (for the month of July), but they have not established a consistent trend in 2012. This mini-rally in August may start fading quickly if the path to recovery suddenly starts looking foggy, especially if we start seeing bad economic data coming out of the US, China and Europe.
There is another threat looming on this rally. As we get closer to the elections and year-end, the issue of a Fiscal Cliff is becoming more and more worrisome for the country. This issue will be politicized and may be even amplified because of the elections.
Then we have Europe. ECB's chairman Mario Draghi gave assurance about saving the Euro "at any cost," easing Eurozone worries in the short term. However, the mess in Europe is far from resolved right now, and in the next couple of months, Wall Street will again start feeling the heat because of Greece, Italy and Spain. As I write this article, bad news have already started, with Standard & Poors cutting Greece's outlook to negative. Upon market close on August 7, the esteemed rating agency said:
"Following delays in implementing budgetary consolidation measures and a worsening Greek economy, we believe Greece is likely to require additional financing. We see the likelihood of shortfalls, owing to election-related delays in the implementation of budgetary consolidation measures for the current year, as well as the worsening trajectory of the Greek economy"
Amidst all this chaos, what are the defensive plays that investors can use to protect themselves and even make profits? Let us take two alternatives into consideration. The entire premise is to stick to a particular sector that consumers can not avoid even if their financial situation goes bad. This sector is composed of companies whose businesses are food, beverages, tobacco and other household items. They are noncyclical in nature and their demand does not slow as much as cyclical companies even in there is sluggish economic growth. In fact, discount foods and the vices - liquor and tobacco - could even see better demand when economic growth slows.
- Buy defensive stocks in the Consumer Staples sector, such as Coca-Cola (NYSE: KO) or Wal-Mart (NYSE: WMT) or Phillip Morris International (NYSE: PM).
The problem with this strategy is that investors get exposed to risks associated to a single stock. This is still not as defensive as one would like when the markets are running all hyper with bullishness.
- Buy the entire consumer staples sector, by owning the Consumer Staples Select Sector SPDR ETF (XLP).
XLP's top five holdings include Procter & Gamble (NYSE: PG), Philip Morris, Coca-Cola, Wal-Mart and Kraft Foods (NASDAQ: KRFT). Almost all the holdings of XLP have traditionally played out as good defensive plays when bull markets recede and talks of sluggish growth are heard around the corner. Usually the staples are goods that people cannot easily cut out of their budgets, regardless of their fiduciary situation. Buying XLP is a relatively safer way to be defensive in this season.
Investors can begin to use the Consumer Staples sector to start defending themselves when the indices reach new highs. Buying individual defensive stocks (albeit with dividends) in this sector will have additional risks, for example foreign exchange risk related to international exposure. Buying the XLP and holding for the next few months is a very good defensive play instead with overall lesser risk.
Codespeed has no positions in the stocks mentioned above. The Motley Fool owns shares of The Coca-Cola Company. Motley Fool newsletter services recommend Philip Morris International and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.