Consumer Staples

The stock market has discounted the high probability of a global recession. Prior declines of similar magnitude proceeded the recession in the mid-1970’s and the depression in the 1930’s. The stock market’s decline should be not only a function of magnitude, but also time.

Stock selection will be more important than usual. Avoid stocks with high debt levels. For now, concentrate on high quality companies with stable and consistent cash flow. Also, focus on stocks with high dividend yields.

OPPORTUNITIES

Stocks in the Consumer Staples sector have traditionally performed better than the stock market, and especially cyclical companies, during market declines. The fundamental explanation is that food, beverage, household products and cosmetics companies manufacture and market brand name consumable products, most of which are considered essential to daily life -- food, drink, toothpaste, deodorants, toilet paper, etc.

Since product demand is relatively stable, the companies should report earnings in line with expectations and, hence, the stocks have outperformed. Generally speaking, food companies generate earnings growth at a mid-to-high single-digit rate. Beverage companies, however, are structurally able to grow faster at the high single-digit to low double-digit rate. But cosmetics companies can grow earnings a percentage point or two above beverage companies. Currently, we rate Estee Lauder (EL - Analyst Report) a Buy.

With the end of 2008, Consumer Staples will have outperformed the market on a total return basis for three consecutive years. Historically, the outperformance of Consumer Staples has lasted only three consecutive years, so the positive performance disparity is long-in-the-tooth. In addition, the relative performance has seasonal attributes, with almost all the relative gain coming in the fourth quarter as investors flee more cyclical investments, which tend to disappoint near the end of the year.

In 2009, it is highly probable that Consumer Staples will underperform once stocks begin to discount the recovery out of the current economic abyss. Therefore, we favor stocks completing restructurings, like Sara Lee (SLE - Analyst Report), and companies that are assisted by special situations, like Dean Foods (DF - Analyst Report) benefiting from lower dairy costs.

WEAKNESSES

For two years, I was a table-pounding buyer of Anheuser-Busch under $50. With a friendly offer of $70 per share from InBev (ABHIF) in mid-2008, I finally downgraded the rating to a Sell.

However, more is brewing in the beer industry: a structural change is about to occur. The excess costs will be wrung out of Anheuser-Busch by InBev. In addition, a joint venture between Molson Coors (TAP - Analyst Report) and SABMiller should produce a more competitive brewer with greater scale, resources and distribution synergies from the optimization of production and distribution networks.

Therefore, the cost rationalization at Anheuser-Busch (instigated by the merger with InBev) and the joint venture between Molson Coors and SABMiller are expected to spark more intense competition, resulting in the loss of the positive pricing trends enjoyed by the industry for the last two years. In other words, a "beer war." Most likely, both companies will pursue higher levels of promotional initiatives and marketing spending. As a result, overall profitability for the industry is expected to suffer.