2022 has been a wild investing year for a myriad of reasons. But one of the craziest events of the year just happened, yet no one is talking about it.
The consumer staples sector is one of 11 sectors in the S&P 500. And along with utilities and healthcare, it has a reputation for being one of the more "recession-proof" sectors. That's because consumer demand for staples isn't as vulnerable to economic cycles. What's more, consumer staples stocks like Procter & Gamble and Coca-Cola tend to pay high dividends, which provides a steady passive income stream.
Until recently, consumer staples had been one of the few sectors that were up on the year compared to the Nasdaq Composite (which is in a bear market), the S&P 500 (which briefly entered a bear market on Thursday), and the Dow Jones Industrial Average (which is in a correction). Yet in a matter of days, the consumer staples sector now finds itself in a correction too as it is down over 10% from its all-time high.
Here's why this dip presents one of the greater passive income buying opportunities in decades.
Fall from grace
In the two-day period between May 17 and May 18, the S&P 500 Consumer Staples Select Sector Index fell by 8.5% while the S&P 500 fell by less than 3%. That drawdown marked the worst two-day percentage decline the index has faced since S&P 500 Dow Jones Indices began calculating its performance on Jan. 28, 2011.
What's more, the largest consumer staples exchange-traded fund (ETF) by net assets, the Consumer Staples Select Sector SPDR Fund (XLP -0.82%), also suffered its worst two-day percentage decline since its inception in December 1998. This ETF manages roughly double the assets of Cathie Wood's flagship Ark Innovation ETF. So even though it doesn't get nearly the headline attention as Wood's funds, it's worth understanding that this is a very sizable ETF whose holdings likely impact many retirees and risk-averse investors.
Why consumer staples are falling
The sector-wide sell-off is due in large part to weak earnings and disappointing guidance from Walmart, which reported on May 17, followed by Target, which reported on May 18. Both companies signaled that although revenue is strong, higher costs are leading to margin deterioration, which is pressuring both companies to increase prices. Higher prices could lead to weakening consumer demand.
We saw similar commentary from Procter & Gamble and Coke's earnings calls. A weakening consumer demand won't affect these companies as much as, say, the consumer discretionary sector or industrials -- which are more cyclical. But if the consumer demand is weakening and costs are rising, then that's a one-two punch that may hit consumer staples companies more than a typical recession.
Where to go from here
What makes 2022 so different than past recessions is inflation, plain and simple. The Federal Reserve is raising interest rates to combat inflation when normally it would be lowering them to help the economy avoid a recession.
"Safe stocks" are less safe because they are fighting a war on two fronts against weakening consumer demand and rising costs -- which isn't normal for a recession. Oil and gas prices are at eight-year highs after being at multi-decade lows just two years ago. The housing market is still red-hot, yet mortgage interest rates went from just over 2% to over 5% in a matter of months.
In the last three years, we transitioned from an economic boom to a pandemic-induced recession, to massive government spending that lifted the economy out of the recession, to overspending and demand that has outpaced supply. Put another way, consumer demand was artificially propped up by low interest rates and stimulus. And now, we are descending back to reality.
No one knows what's going to happen in the short term -- whether we are going to get a recession, how long it will last, or how low stocks will fall. But we do know that when top dividend stocks like P&G, Coca-Cola, Target, and Walmart go on sale, it's usually a great time to buy. No matter how bad things get, chances are that leading consumer staples companies are going to do better than the average stock in the S&P 500.
For investors looking for companies they can count on to endure tough times and pay stable and growing dividends, the sell-off in the consumer staples sector looks like a fantastic buying opportunity.