The performance differential between US large cap Technology and Consumer Staples stocks over the last 3 months has been dramatic. Tech is 3.5% lower. Staples are 3.5% higher. And since the former outweighs the latter in the S&P 500 (21% to 7%), this difference goes a long way to explaining why the 500 is down 1.2% over the last 90 days.
While this Tech/Staples swap may seem like a “Growth vs. Value” asset allocation shift, it really isn’t. Consumer Staples actually trade for a higher valuation than Tech at the moment. According to FactSet’s latest data, Staples trade for 17.7x 12-month forward earnings while Tech is slightly cheaper at 16.9x. And both are expensive to the market, which trades for 15.9x.
What’s really happening: a classic risk-off trade, selling more volatile names and buying shares of companies with steady-Eddie earnings. One other possible explanation – reweighting portfolios as interest rates rise – isn’t very compelling. The best thing about large cap Staples, aside from their predictable businesses, is a 2.7% yield. And that becomes less attractive by the day as interest rates rise.
We got to wondering how this push-pull between US large cap Tech and Staples has worked over the last 20 years; is the recent shift an important warning sign? Three data points answer that question, using trailing quarterly/1-year returns (chart at the end of this section):
#1. Tech structurally outperforms Staples across capital markets cycles, but the performance pendulum swings wildly.
- Since late 1998 the Tech sector of the S&P 500 has beaten Staples by an average of 1.7 points on a trailing 1-year price return basis.
- The standard deviation of that relative performance is wide, at 23 points. In other words, Tech can outperform Staples by up to 23 points better before the group is “unusually” stronger than its more-stable peers.
- In mid-June 2018 we hit a 40-point relative annual outperformance for Tech, at +29% trailing 1-year price returns versus -10% for Staples.
Bottom line: Tech’s recent underperformance makes sense when you realize that its relative move versus Staples essentially hit 2-standard deviation outlier levels in mid-June. Why was this not more obvious 3 months ago? A look at the chart tells the story. Unlike every prior period when Tech outperformance hit essentially 1-standard deviation (+20) relative performance, the 2017-2018 experience wasn’t a short spike like 2003, 2008 o 2010. It looked permanent.
#2. A shift from Tech to Staples does not necessarily presage a broad market decline.
- If you are worried the current Tech-Staples swap looks a lot like the dot com bubble bursting, realize that Tech stocks had a trailing 1-year return differential of +100 points (+79 for Tech, -24 for Staples) in late March 2000. Their peak for this cycle (June 2018) was 40 points, as mentioned.
- The last time Tech outperformed Staples by +40 points over the trailing 1-year period was in November 2009, on the snapback rally from the March lows. The total return on the S&P 500 the following year (2010) was 14.8%.
- Prior to the recent (2017-2018) run-up for Tech, the last time the sector got close to beating Staples by 20 points (close to that 1-standard deviation level) was late June 2014 at 19 points (+27% for Tech, +8 for Staples). Average total returns for the S&P 500 in 2014-2015 were 7.5%.
Bottom line: the swap from Tech to Staples this late in a cycle is worrisome, but don’t guaranty total S&P 500 returns will be negative going forward. The 2014 experience (and what we’re seeing right now) does show returns will be below average, however.
#3. On a trading basis, historical data shows Tech may continue to underperform Staples in the near term. In addition to the annual return data we also looked at 60-day (roughly 3 trading months) relative returns for Tech and Staples (email us if you want to see any of this data).
- Staples have outperformed Tech by 6.8 points over the last 60 trading days.
- The mean for this data series is 0.5 points (Tech outperforming Staples), with a standard deviation of 10.2.
- Tech will not be noticeably oversold to Staples until it underperforms by another 2.9 percentage points (one standard deviation = 9.7 points, currently 6.8 points).
Bottom line: as much as we like US large cap Tech, we recognize the current reset and advise waiting until the sector washes out a little further. We’ve read a lot of Street commentary that says the group is at a near term bottom. Consider our work here a statistical counterweight to that commentary. We’d love to be wrong on this near-term call, but the numbers say otherwise.