Are Defensive Sectors Still Defensive?


It's no secret that defensive industry sectors like consumer staples and utilities have been leading major U.S. stock market benchmarks to all-time new highs. But have stocks in these sectors become overvalued?

The Consumer Staples Select Sector SPDR ETF (NYSEARCA:XLP) tracks 42 companies within the S&P 500 involved in food and beverage, drug retailing,  household, and personal consumer products.

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Among the stocks within XLP that have valuations exceeding the broader market include Hershey (NYSE:HSY) with a P/E ratio of 29, Colgate-Palmolive (NYSE:CL) at 23, and Kellogg Co. (NYSE:K) at 23. By comparison, the SPDR S&P 500 ETF (NYSEARCA:SPY) carries a P/E ratio of around 15.

The list of boring consumer stocks selling at a premium to the market has pushed the entire staples sector to a P/E level over 17, according to Alta Vista Research. That makes XLP the richest valued sector among the SPDR ETFs tracking the other eight S&P 500 sectors.

The P/E or price earnings ratio measures stock valuations. It's calculated by taking a stock's market price divided by its annual earnings per share.

For instance, if a company is currently trading at $40 a share and earnings over the last 12 months were $1.50 per share, the P/E ratio for the stock would be 26.66 ($40/$1.50).

Currently, consumer staples represent around 11.15% of the S&P 500. Another defensive sector, utilities (NYSEARCA:XLU) which makes up just 3.65% of the S&P 500, also trades at a premium. The Utilities Select Sector SPDR ETF (XLU) owns 31 stocks involved in generating and distributing both electric and natural gas power.  XLU has gained 18.48% since the beginning of the year and has a P/E ratio of 16.7. 

Overstretched valuations alone are not necessarily a sell signal. But properly used in conjunction with other indicators, it most certainly raises cautionary red flags.

The May 2013 issue of the ETF Profit Strategy Newsletter examines the fundamental and technicals for ETFs linked to major asset classes. It includes our short list of mega investment themes, top performing and yielding ETFs, along with our popular Technical Forecast that's updated several times per week.