XLP: Have You Tried Staples?

by Dan January 29, 2016 2:07 pm • Commentary• Trade Ideas

Regular readers know that I have been less than optimistic about the return environment for equities globally with the end of QE in late 2014, and the end of ZIRP this past December.  I know I know, there are few alternatives to owning stocks in this rate environment, but it’s been my view that the Fed’s unwind of QE caused the industrial commodity collapse as they took their foot off of the neck of the U.S. dollar.  Well, the end of crisis monetary policy in the U.S., and the subsequent rip in the U.S. dollar has not only caused an epic capital flight out of emerging markets, at a very fragile time for most of the debt ridden countries, but has served as a massive headwind to U.S. muli-nationals corporate profits, especially those who rely on emerging markets like China for future growth.

While I have attempted on numerous occasions in the last few months to find long positions that should benefit from investor’s desire to seek safety in companies that rely on the U.S. sales, that also have healthy dividend yields, with the backdrop of a rising dollar and lower Treasury yields (see long trade ideas in XLU, VZ, UUP, TLT & PFE here). On the single stock side of things, I have now changed my view a bit given the recent performance of U.S. Telcos and Utilities, while staying committed to the notion that the dollar will continue to rise vs the Euro, Yuan and the Yen as all remain committed to future easing and as negative interest rates are a thing in Europe and Japan and as the Yuan has a downward trajectory.

One massive beneficiary of investor desire for yield and the defensive nature of their products has been consumer staple stocks like Proctor & Gamble (PG) which is up 3% this year, Coca-Cola (KO) and Pepsi (PEP) which are both basically flat on the year.  The problem I have with these stocks that aside from their dividend yields of around 3% they all trade 22x this year’s expected earnings that are already expected to be flat or down, all with 55 to 60% of their sales from outside the U.S., with much of their expected future growth coming from over seas.

The Consumer Staple etf, the XLP, is heavily weighted to these large cap multi-nationals, with KO, PEP & PG making up 25% of the weight of the etf.  The XLP has traded in a fairly tight range over the last year (excluding its summer swoon from a then all time high in July of 15%) spending the better part of its trading between $48 and $51:

XLP 1 year chart from Bloomberg
XLP 1 year chart from Bloomberg

Taking a longer term view, the uptrend that has been in place since the 2009 lows would put a re-test back in the mid $40s:

XLP 10 year chart from Bloomberg
XLP 10 year chart from Bloomberg

Short dated options prices in the XLP seem fair, with 30 day at the money implied volatility at about 15%, just above the one year average:

XLP 1year chart of 30 day at the money implied volatility from Bloomberg
XLP 1year chart of 30 day at the money implied volatility from Bloomberg


I am going to make a defined risk bearish bet that continued dollar strength, with what looks like and impending breakout of the DXY could cause investors to re-consider yield over valuation and declining earnings.

*Trade Idea: XLP ($50.75) Buy March 50/45 put spread for 80 cents

-Buy to open 1 March 50 put for $1

-Sell to open 1 March 45 put at 20 cents

Break-even on March Expiration:

Profits: of up to 4.20 below 49.20 with max gain at or below 45

Losses: of up to .80 above 49.20 with max loss of .80 above 50

Rationale: This fades recent strength with defined risk and is a positions set-up for more broader market weakness in the next few months.