The consumer staples have been rallying furiously over the past few weeks, and that's become a real head-scratcher for many. After all, this is a group that has shown very little growth, with multiple earnings cuts and nothing -- no hook, nor a story line to grab on to.
What's behind the move? What has the stock of Kraft Heinz Co. (KHC) jumping five points out of nowhere? How can General Mills (GIS) rally from $42 to $47 on nothing? How does a group with companies considered moribund go from being hated to loved?
Well, let's look at the recent turn of events:
- First, a series of very negative events recently pummeled the group. Prior to that, consumer staples had been buoyed by yield (the sector's stocks all pay above-average dividends).
- Second, these stocks began to have a series of very subpar quarters, where we started hearing about rising transportation costs and raw costs running rampant. We had previously been lulled into thinking that these companies had been benefiting from commodity tailwinds for ages.
- Third, investors' money was going elsewhere, fleeing toward domestic companies without a lot of China exposure. The industrials took it on the chin from this rotation, and so did consumer staples.
All of this prompted Credit Suisse to downgrade the group in May, saying that the sector had rising costs and little growth, so there were much better places to be. Then on May 17, Campbell Soup Co. (CPB) reported a totally God-awful quarter and fired CEO Denise Morrison, who had been trying to engineer a turnaround at the venerable soup-and -snack company.
That caused the entire group to be radically sold -- but also caused a bottom. And that's when the renaissance began.
I mark this change as starting with the earnings from PepsiCo (PEP) -- ironically, because the company announced early Monday morning that Indra Nooyi (one of my favorite CEOs) is retiring. Many hedge funds had bet against PEP in light of the fact that the soft-drink giant's previous quarter had been nothing to write home about. But that all changed when PEP's latest quarter reversed some negative trends, helped by better ad spending that staunched category losses to Coca-Cola (KO) . There's so much more to PepsiCo than its battle with Coke, but it often seems like that's all that people care about.
Second, the stock market is a remarkable place because it very quickly extrapolates bad news all across a given sector. So, the notion that transportation costs were an issue for consumer staples or that commodity costs could be a problem quickly became embedded in the sector's "narrative." Once that happens, you don't care all that much by the time the third or fourth company tells you about it. I guess you could call this "transportation-woe fatigue."
Third, the companies began to talk about how their lower U.S. corporate-income-tax bills have begun to impact their bottom lines. Even if business was just marginally better, the fact that their tax rates quickly went down (mostly to 21%) meant that companies had more money to spend, more money to acquire things with and more money for stock buybacks.
Then last week we got a call from Procter & Gamble (PG) that brought about a new mindset. P&G said it was going to put through price increases on its paper products to offset the raw costs. Most observers hasn't thought that anyone would try to raise prices, so the group seemed to be instantly re-rated upward -- including P&G, which saw its stock go up despite an acknowledged earnings disappointment.
Kimberly Clark (KMB) , which had been putting in a bottom, also suddenly took off, as it has the most to gain from PG raising prices. In fact, the whole group -- including Conagra Brands (CAG) , which had been hurt by a deal to buy Pinnacle Foods (PF) at what was thought to be too high a price -- emerged positively.
Then we got a one-two-three punch of good earnings from Kellogg (K) , Clorox (CLX) and Kraft Heinz. All three trounced earnings estimates and gave analysts reason to raise second-half numbers. All three also had miraculous cost control -- so great that they offset increases in raw costs. Additionally, all three talked about how business is back on track.
Their drumbeat was so loud that it allowed P&G's stock price to keep climbing despite earnings that missed the mark. In fact, the group has now experienced almost two months of stock-price increases.
Now, I do worry that just as we got a bottom on bad news from Campbell Soup, we might level out here with all of the good news spread among the group. The idea of returning to even the smallest growth possible before hitting zero is compelling, but I don't know if it's compelling enough to continue to propel the sector without more takeovers. They are richly priced, especially against stocks like Apple (AAPL) , a consumer-product company with a price-to-earnings ratio two clicks lower than the average consumer-product company.
How will we know if the consumer staples have peaked? Well, we'll need to see a round of overall upgrades -- a re-rating of the group up, just like we had a re-rating of the group downward by Credit Suisse near the bottom.
When that happens, exit and exit fast. After all, only PepsiCo has real earnings momentum, while Clorox has a serious turn ahead. But that said, I can't blame anyone from turning to this rather immune group for safety in a world of expensive stocks and an unsafe moment, with trade wars right in front of us.
(This column has been updated with the news that PepsiCo CEO Indra Nooyi is retiring.)