Sector Strategy: Stick With Consumer Staples

At the risk of sounding melodramatic, if someone had put a gun to my head at the beginning of the year and asked me which S&P 500 sector would work best in 2009, I would have said consumer staples. And I would have been wrong, so far.

As of this writing, the S&P 500 is down 8.9% and the consumer staples sector is down 9.7%, while technology is actually up 5.5%. I bet no one would have picked technology as the winner, but there it is.

Why choose staples in such a theoretically dangerous market? Well, people always need to eat, drink, smoke, and bathe. So companies like Procter & Gamble (NYSE: PG  ) and Kimberly-Clark (NYSE: KMB  ) can count on ongoing revenue streams, even when times get tough.

Yet, the sector hasn't paid off lately. This tells me that many of these companies are down for no good reason, other than that money is probably still flowing out of the market. If you sell an index fund position, the fund sells all the stocks in the S&P 500 according to their weight, regardless of the fundamentals. I think a lot of babies have been thrown out with the bathwater in the consumer staples sector, which you can track via the Consumer Staples SPDR (NYSE: XLP  ) . Here are a few of my favorites.

Drink up
Now, Diageo (NYSE: DEO  ) is not a member of the U.S.-only S&P 500, since it's based in London. The closest consumer staple stock in the S&P 500 is Brown-Forman (NYSE: BF-B  ) , which makes Jack Daniels and other fine refreshments, but I think Diageo is the more interesting company.

Diageo is the premier spirits stock to own as it makes primarily premium spirits, wine, and beer -- Johnny Walker, Smirnoff, Guinness, Tanqueray, to name a few. The stock has been hammered recently, taking a double hit from both the overall market's malaise as well as a 25% drop in the value of the British pound over the past year.

Does the pound have more downside? Possibly. I am a big euro bear, and the pound and euro are very much interlinked. But because Diageo exports plenty of its products to the U.S. and elsewhere, a weaker pound may actually help Diageo's bottom line.

The company has seen product volumes decline 2%, as people have economized, but sales in money terms actually rose 3% for the first part of fiscal 2009, and earnings per share rose 21%. That's not bad in the current economic environment.

Target or Wal-Mart?
According to S&P, Wal-Mart (NYSE: WMT  ) is part of the consumer staples group, while Target (NYSE: TGT  ) is part of the consumer discretionary economic sector. Do you really see that much difference? Well, performance-wise, Wal-Mart is a staple. The company saw its annual revenue climb 7% to $401.2 billion last year. That says a lot, as retailers are notoriously vulnerable when consumer spending contracts. Consumer spending has fallen as the savings rate is rising, but consumers are apparently switching away from other retailers and directing their dollars toward Wal-Mart.

Target, on the other hand, has seen its profits decline recently. In February, Wal-Mart saw same-store sales rise 5.1%, while Target's dropped 4.1%. One key has been the more extensive offering of food and other basic goods at Wal-Mart, while consumers have cut spending on clothing and other less-essential items, hurting Target.

If we are anywhere near the low point of this recession, Target actually might make a better buy as it should see more improved performance as the economy recovers. But that's a very big "if," as, in my view, this is no ordinary recession. With consumers de-leveraging by paying down unsustainable debt burdens, they'll likely give up even some of the most modest luxuries and concentrate solely on things they absolutely have to have.

Until that changes, the recession will likely continue. That should make you focus on consumer staples -- companies that sell things you can't do without -- rather than consumer discretionary stocks.

More on defensive stocks:

Diageo, Kimberly-Clark, and Procter & Gamble are Motley Fool Income Investor selections. Wal-Mart is a Motley Fool Inside Value pick. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters today, free for 30 days

Fool contributor Ivan Martchev does not own shares in any of the companies in this story. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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