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When a leading company in a major sector implodes, it's hardly surprising that investors shy away from the entire group. In the most spectacular recent case, Procter & Gamble's (PG) latest earnings shortfall and management shakeup has thrown cold water on investors' enthusiasm for stocks of companies that sell consumer staples.
The sector had picked up since the tech-stock dive because it's a well-known defensive play. But now that the economic statistics show a slowing economy -- decreasing the odds that the Federal Reserve will raise interest rates yet again -- many investors are getting more optimistic about the stock market and becoming less concerned with playing defense.
For such investors, P&G's 50% slide from its 52-week high is exhibit A when it comes to proving that food, beverage, consumer products, tobacco, and health-related companies aren't in a position to provide strong earnings growth. On June 8, P&G, which in March warned investors that it couldn't meet expectations, said again that it's earnings would fall short. Some reasons are company-specific, but the others include woes that are familiar to multinational consumer products companies: fierce price competition, lack of exciting new products, slow volume growth, and a negative currency impact.
Even more unfortunate for these stocks, "the market is still very hopped up on growth," says Charles Carlson, manager of the Strong Dow 30 Value Fund. He adds that he has underemphasized P&G and Coca-Cola in his portfolio, because "they are growth stocks that can't grow anymore," although the fund must own all Dow components.
PREPARE NOW.
Even if the consumer-staples sector can't claim hot growth, though, it may merit consideration in its traditional role as a hedge. The familiar logic goes like this: In a slowing economy, people still need to eat, shave, and do laundry. And a look at how well the consumer-staples sector did while tech stocks were crumbling a few weeks back shows the wisdom in diversifying now -- for when the market turns negative again.
From the Nasdaq's peak on Mar. 10 through June 15, consumer staples rose 19% (even though P&G makes up about 5% of that sector), while the Nasdaq fell 25% and the S&P 500 rose 5%. "The last three months have reaffirmed why these stocks deserve some position in your portfolio," says David Sowerby, a portfolio manager at Loomis, Sayles & Co. "They have worthy characteristics, particularly as there are more gray hairs in the economy." Douglas R. Cliggott, U.S. investment strategist at J.P. Morgan Securities, recommends that investors keep 24% of their stock holdings in this area, twice the sector's weighting in the S&P 500.
That still leaves the tricky business of choosing stocks that won't disappoint the way P&G has. Sam Stovall, sector strategist at Standard & Poor's, says he's neutral on consumer staples as a whole. He recommends avoiding household-products names such as Colgate-Palmolive, P&G, and Clorox, as well as the tobacco companies, which are vulnerable now to large punitive-damage awards.
BOTTOMS' UP.
Stovall is positive on the prospects for several subsectors, however. "The beverage category looks good," he says, citing improving sales and pricing power. S&P, which like Business Week is a unit of the McGraw-Hill Companies, recommends alcoholic beverage sellers such as Anheuser-Busch, Canandaigua Brands, and Adolph Coors. Pepsi and bottler Whitman are among Stovall's favorites in the nonalcoholic beverage category.
Food and drug distributors are another bright spot in the sector, he adds, citing Cardinal Health, which distributes health-care products, and Fleming, Sysco, and Supervalue, which distribute food. Albertson's is the only food or drug retailer that S&P currently recommends accumulating, he says.
For his portfolios, Sowerby has profited from recent gains in Disney, Anheuser-Busch, and Kimberly-Clark, and thinks those names will continue to do well. John Garrity, associate research director at Investec Ernst & Co., says he's mainly avoiding the consumer staples area. But -- against the grain -- he thinks Philip Morris is a good buy because he believes the worst of its legal problems are behind it and that the company is a "powerhouse in terms of cash flow and earnings."
For a defensive play with growth potential, Garrity is a big fan of the combined Pfizer/Warner-Lambert. The pharmaceutical giant will have a stable of blockbuster drugs as well as its strong drug pipeline, he says.
"CHOPPY TRADING."
"There are some pockets of strength," in the sector, concedes Carlson, pointing out that Pepsico has reached new highs, thanks to the strength of its Frito-Lay brands, and that Coke climbed 3 1/16, or 6%, to 56 1/16 on June 15 after Salomon Smith Barney upgraded it to "buy." But he thinks such stocks won't really perform well until the market becomes more value-oriented. Until then, he expects to see "short-term rallies and choppy trading."
He's probably right. But market sentiment can change on a dime, as the Nasdaq's spring slide shows. It's part of a money manager's job to anticipate such shifts and quickly reposition portfolios. The average investor, who until recently has been making hay with hot tech stocks, may find it safer to diversify into consumer staples now.
Amey Stone covers investing for Business Week Online
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