Top Wall Street Strategist Has 10 Big Reasons to Avoid This Red-Hot Sector

By Lee Jackson Updated Jan 12, 2:25PM EST · Published Feb 28, 10:35AM EST

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Top Wall Street Strategist Has 10 Big Reasons to Avoid This Red-Hot Sector — © Thinkstock

[cnxvideo id=”509524″ placement=”ros”]While the market as a whole has been strong since the election, we are also in what appears to be a gasping-for-air rally, which for all intents and purposes is almost eight years old. While stocks can go higher, some out there may be thinking the time has come to shift assets to sectors that are more conservative as they tend to perform better when the going gets tough.

One of those sectors is consumer staples, and while the logic to own shares is that we all have to buy the necessities that go with day-to-day living, there are also reasons to avoid the sector. When those reasons come from Savita Subramanian, who is one of the outstanding Equity and Quant Strategists at Merrill Lynch, we tend to take a closer look.

While the sector has lagged the overall market since the election, it has outperformed for the last six weeks. Given what happened to Target after releasing very poor results and guidance, it makes sense to check out Subramanian’s 10 reasons to avoid shares and stay underweight the consumer staples sector.

1. Price-to-earnings (P/E) multiples have expanded with very little earnings per share (EPS) growth. The sector multiple has risen more than any other on lesser earnings growth.

2. Weak fundamentals: Sales and earnings are below average, and analysts around Wall Street are cutting estimates. They also note that EPS growth from cost-cutting looks maxed out.

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3. Staples are not the sector to own when S&P 500 profits as a whole are growing, and Merrill Lynch sees them growing in 2017.

4. The sector is also negatively correlated to inflation at all levels. That includes consumer prices, producer prices, commodity prices and wages.

5. The sector is also negatively correlated to rising interest rates as it serves as a bond proxy sector when rates are artificially low like they have been for years. And rates are going higher.

6. Ditto a stronger dollar: Consumer staples is the most foreign-exposed defensive sector. While it has historically outperformed during periods of a stronger dollar, the correlation is weak, and it recently turned negative. Plus, the sector has big exposure to emerging markets, where higher rates and a strengthening dollar can hurt.

7. The border adjustment tax could subtract as much as 11% from 2018 EPS estimates. That’s the largest for any sector except energy. While the proposed tax is not a certainty, even without it the sector is still middle of the pack.

8. Staples is the highest quality sector in the S&P 500, and while Merrill Lynch likes high-quality stocks, they are currently lagging lower quality and that could remain in place.

9. The sector benefited from large inflows into low-volatility fund strategies. The low-beta bubble is deflating, according to the analysts, and outflows from these funds have increased. Of course outflows means selling.

10. Merrill Lynch usually takes a medium-term horizon on sector calls, but the team also makes the case that short-term investors may also want to avoid the sector.

Subramanian and the Event and Quant team are among the best on Wall Street, and it makes sense for all the reasons listed above for investors to underweight the sector. It doesn’t mean sell everything immediately, but it does suggest moving to areas where the opportunity is better now.

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About the Author Lee Jackson →

Lee Jackson has covered Wall Street analysts' equity and debt research and equity strategy daily for 24/7 Wall St. since 2012. His broad and diverse career, which included a stint as the creative services director at the NBC affiliate in Austin, Texas, gives him unique insight into the financial industry and world.

Lee Jackson's journey in the financial industry spans over 30 years, with nearly two decades as an institutional equity salesperson at Bear Stearns, Lehman Brothers, and Morgan Stanley. His career was marked by his presence on the sell side during pivotal Wall Street events, from the dot.com rise and bubble to the Long Term Capital Management debacle, 9/11, and the Great Recession of 2008. This is a testament to his resilience and adaptability in the face of market volatility.

Lee Jackson’s practical financial industry experience, acquired from a career at some of the biggest banks and brokerage firms, is complemented by a lifetime of writing on various platforms. This unique combination allows him to shed light on the intricacies and workings of Wall Street in a way that only someone with deep insider experience and knowledge can. Moreover, his extensive network across Wall Street continues to provide direct access for him and 24/7 Wall St., a privilege few firms enjoy.

Since 2012, Jackson’s work for 24/7 Wall St. has been featured in Barron’s, Yahoo Finance, MarketWatch, Business Insider, TradingView, Real Money, The Street, Seeking Alpha, Benzinga, and other media outlets. He attended the prestigious Cranbrook Schools in Bloomfield Hills, Michigan, and has a degree in broadcasting from the Specs Howard School of Media Arts.