With an economic slowdown anticipated, some investors are taking overweight positions in consumer staples.Reuters
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With borrowers facing high debt-servicing costs, many economists expect a period of belt-tightening for Canadian consumers. That has important implications for investors about where to allocate their money.
“Caution is warranted,” says Christine Tan, portfolio manager at SLGI Asset Management Inc., Sun Life Financial Inc.’s mutual fund arm. “There is a fair amount of distress in the Canadian economy and consumer base.”
Enter consumer staples stocks such as grocery chains and the food producers who supply them. The sector, which includes companies such as Metro Inc. MRU-T, George Weston Ltd. WN-T and Saputo Inc. SAP-T, is a tried-and-true corner of the Toronto Stock Exchange (TSX) that has exhibited resilience in tougher times, delivering stable profits and reliable – if unspectacular – dividend yields.
“Consumer staples make sense in this kind of context because, generally, they’re businesses that are less exposed to the economic cycle,” Ms. Tan says.
The S&P/TSX Capped Consumer Staples Index pays a yield of just less than 2 per cent, according to Bloomberg LP data. That’s lower than the S&P/TSX Composite Index’s benchmark average of about 3.4 per cent, which is boosted by higher-yielding sectors such as banks and telecoms.
Consumer staples stocks comprise about 4.5 per cent of the overall index weighting compared with financials at about 30 per cent, energy at 18 per cent and industrials at 15 per cent. That means investors with index investments such as broad-market exchange-traded funds are more exposed to the cyclicality of the overall economy, Ms. Tan says. By allocating a larger percentage into consumer staples, investors are betting the economy will worsen and that their holdings are better protected in businesses that will not suffer as much during a recession while paying out a small dividend yield to boot.
With the Canadian economy plodding along – or worse, contracting – many portfolio managers have taken such a view.
“Our managers are generally slightly overweight staples, and have been for a little while,” Ms. Tan says. “We own staples for the defensiveness of the businesses, and sure, a bit of a yield. But you have to be careful what valuation you pay for it.”
Canadian recession expectations have been elevated since the Bank of Canada (BoC) commenced its current interest rate-hiking path in 2022, with investors piling into consumer staples over the past year and a half. “We would be a bit cautious on staples today because of how much they’ve outperformed,” she says.
Indeed, consumer staple stocks as a group have climbed more than 30 per cent since the BoC made its first interest rate hike compared with an approximately 20 per cent increase for the broader index, Ms. Tan says. The group is currently trading at the higher end of its historical valuation range while the TSX is lagging.
“They have had a decent run compared to many other sectors,” says David Bromley, senior wealth advisor and portfolio manager with Bromley Wealth Management Team at National Bank Financial Wealth Management in White Rock, B.C. “Not huge run-ups as we’ve seen, say, in technology, but some portions of the sector are fully valued.”
Yet, Mr. Bromley says the stability and defensiveness the sector provides a portfolio through a downturn outweighs the current overvaluation risk.
“People will still buy groceries and buy food products, so we don’t feel they’re overvalued in any way at this point,” he says.
A vehicle such as iShares S&P/TSX Capped Consumer Staples Index ETF XST-T offers exposure across 11 securities, capping any single position at 25 per cent. The fund’s top holdings, at about 23 per cent each, are Loblaw Cos. Ltd. L-T and Alimentation Couche-Tarde Inc. ATD-T, one of the largest fuel station and convenience store operators in the world.
Getting exposure beyond Canada is important, says Patti Dolan, senior wealth advisor and portfolio manager with the Wagner Investment Management Team at Wellington-Altus Private Wealth Inc. in Calgary.
“The Canadian market is small, so having an international exposure gives you a broader set of opportunities,” she notes. Because of Alimentation Couche-Tarde’s international presence, it’s less correlated to Canadian stocks, providing a layer of diversification within the sector exposure as well.
Ms. Tan says waiting for a drawdown before stepping into a position may make sense. As some investors begin to peer through the recession and rotate to early-cycle sectors such as materials and industrials, opportunities to buy consumer staples at lower valuations may open up.
Yet, the sector has commanded a small premium historically, she adds: “Staples have always been more expensive than the overall TSX and more cyclical sectors – investors recognize their stability and defensiveness, and are willing to pay a bit more.”
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