Head-Scratching Action in Grocery Stores

 | Jan 22, 2014 | 3:00 PM EST
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Of the defensive and income-producing investing strategies I write about, one of them concerns mid-tier grocers -- among which we currently like Safeway (SWY) and Kroger (KR). The idea is pretty simple: Regardless of economic activity, consumers need to eat. Other than eating less, there are few substitutions for the products offered through the grocers.

So we continue to like and hold those two names for our income clients, though it hasn't been smooth sailing over the past five years. While these stocks have enjoyed positive overall trends, they've also moved erratically. That puts income investors in an uncomfortable position, as such folks typically want income and low volatility to principal. It also forces advisors to constantly question their underlying thesis, as well as their rationale for holding even defensive income positions.

I discussed this issue a year and a half ago, at which point Safeway and Kroger had respectively sunk 28% and 11% over the prior six months -- enormous moves for these kinds of stocks. The declines were driven by speculators' expectations that a recovering economy would shift more confident consumers away from the mid-tier providers, and toward higher-end grocers such as Whole Foods Market (WFM) and The Fresh Market (TFM).

I didn't like that rationale then, and still don't like it today. Since that point, speculators seem to have arrived at the same conclusion: Fresh Market shares were almost at their all-time high a year and a half ago, and the stock has since declined by almost 50%. While Whole Foods is up about 10% for that period, it has also lost 20% just in the past few months.

A year and a half ago, my conundrum lay in speculators' shift from the mid-tier to high-end grocers. Now I'm attempting to parse why there has been a dramatic reversal in speculators' expectations here. After all, at this point there's a general market consensus of an improving economy -- or, at least, much more so than what had been the case in mid-2012.

I'm not quite sure why that is.

One of the other shifts I mentioned in 2012 was the migration away from the mid-tier grocers to the bulk providers like Costco (COST). The idea here was that many consumers, especially families, were making a commensurate shift toward the lower-cost produce available at Costco, even as increasing economic activity was bound to bolster sales at Fresh Market and Whole Foods. Yet, in similar fashion to Whole Foods, Costco's big gains since mid-2012 have pared back significantly over the past few months.

To be fair, shares of Safeway, Kroger, and Wal-Mart (WMT) have all declined in the past few months as well. That said, they respectively offer dividend yields of 2.5%, 1.8%, and 2.5%. That compares the Costco, Fresh Market and Whole Foods payouts of 1.1%, zero and 0.9%, respectively.

I don't want to overanalyze the situation, but it appears as if one of two patterns are being exhibited by speculators.

One possibility is that they are buying into the financial-media meme that near-term economic prospects near are no longer as strong as they were.

But here's the other possibility: that this has nothing to do with macroeconomic issues, and everything to do with the tech sector. Specifically, tech's performance may have created a vortex of positive expectations, and the space could therefore be sucking in a rising percentage of capital to the detriment of other sectors, especially those with little or no dividend.

If you're looking for growth, the tech patch is the place to be -- so if I had to choose which of the above two scenarios is more likely, I would go with the latter one.

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