What do you get when the stocks everyone runs to in a crisis are trading at price-earnings ratios that eclipse pretty much every other industry? Frayed nerves.
It's happening in U.S. consumer staples, companies from Campbell Soup Co. to Kellogg Co. that fetch the highest prices relative to profits in 12 years. At 21 times earnings, companies that provide essential products and services are more expensive than everything else in the Standard & Poor's 500 Index apart from energy shares, whose income travails distort the comparison.
For investors in need of a hero amid markets whose volatility matches anything in five years, high-priced defensives aren't making it easier. Take daily stock swings. In the consumer staples subindex of the Standard & Poor's 500 Index, moves have averaged 0.86 per cent in 2016, compared with 0.57 during the rest of the bull market.
"People are paying a higher valuation for the greater probability that their capital is going to be preserved in these defensive sectors," Neil Azous, founder of Stamford, Conn.-based Rareview Macro LLC, said. "The dilemma is that some people don't believe the recession chances are high enough to warrant that valuation, so it makes it a very difficult decision."
Investors have piled into staples shares since the S&P 500's correction in August. The group has rallied 11 per cent and at one point outpaced the benchmark gauge for 12 straight weeks, the longest stretch since at least November 2007, when the U.S. economy was on the brink of its last recession.
Like any expensive asset, high valuations conceivably make the stocks more vulnerable to disappointment. Dr Pepper Snapple Group lost 2.9 per cent Wednesday on a 2016 earnings projection that fell short of analysts' expectations -- even as the company topped estimates for both earnings and revenue in the fourth quarter.
Valuations are keeping some investors out of the stock market. Hamish Douglass, whose Magellan Global Equity Fund beat 99 per cent of peers over the past five years, boosted cash to about 14 per cent of assets by April, saying "we're holding cash rather than the most defensive equities we would have otherwise held."
Earnings in the 38-member group declined in the fourth quarter, with profits falling 2.2 per cent from a year ago, according to data compiled by Bloomberg. While earnings beat analysts' estimates, revenue missed expectations by an average 1.5 per cent. The biggest losses in the sector came from food, beverage and tobacco companies.
"In a yield-starved world, investors have been chasing perceived safety and dividends," said Larry Pitkowsky, co- founder and co-managing partner at Goodhaven Capital Management LLC, where he oversees $450-million. "However, in investing, safety is usually tied to price, and the more expensive, the less secure the investment."