Chart of the Day – Health Care vs. Consumer Staples

by Enis September 6, 2012 1:45 pm • Commentary

Dan and I have been debating the merits of the Staples sector for the past week.  Dan’s been harping on the recent weakness of some of the former darling safe haven names, like KO or MO.  He put his money where his mouth is with his PG put spread today.  And he’s pretty much convinced me, despite my initial skepticism, that the Staples sector is overvalued.

When I look at the chart of XLP, the Staples ETF, it is generally not one I would look to short:

 

 

This is a strong 3 year uptrend, more impressive than the broader market’s uptrend because of the lack of drawdowns on the XLP chart.  Long XLP has been a very favorable Sharpe Ratio trade (low volatility for the resulting return).

On a longer term basis though, the sustainability of this trade seems in question.  One way to measure the viability of an investment is to compare it to your alternatives.  The largest components of XLP are PG, KO, PM, WMT, KFT, and PEP, essentially all staid, familiar corporates with dividend yields of 2-4%.  They all have a P/E between 15 and 20, and projected earnings growth in the 10% per year area.

Now compare that to XLV, the health care ETF.  The largest components of XLV are JNJ, PFE, MRK, ABT, AMGN, and UNH.  The first four stocks have dividend yields between 3 and 4%, and P/E ratios between 10 and 14.  AMGN and UNH yield between 1.5 and 2%, with P/E ratios of 14 and 11 respectively.  Projected earnings growth is between 0 and 8% for the first four names, and 10-15% for AMGN and UNH.

On balance, XLP yields 2.5%, while XLV yields 2%.  The strong performance of both ETFs (similar looking charts) has been aided by low interest rates, as investors have piled into secure dividend plays as a result.  But I would argue that XLP is riskier than XLV at current valuations, and has much more room for disappointment in any adverse scenarios.  My bet is that most investors in both sectors reside there because they want to avoid any surprises.  Yet, Staples valuations of 15-20 P/E multiples seems to imply a crowded trade.

Finally, here is a 10 year chart that shows the ratio of XLV / XLP:

 

 

As you can see, XLV resides near the bottom of its 10 year range vs. XLP on a relative basis.  With the corresponding valuation differences, and potentially more international exposure for the Staples sector, this is a story to keep your eye on going forward.