The Consumer Staples Select Sector SPDR (NYSE:XLP) is one of several popular ETFs tracking staples stocks. With over $6.4 billion in assets under management, XLP is home to 44 stocks, including an array of familiar names such as Procter & Gamble (NYSE:PG), Coca-Cola (NYSE:KO) and Colgate-Palmolive (NYSE:CL).
In a testament to the strength of the staples sector this year, Costco (NASDAQ:COST) is the worst performer among XLP's top-10 holdings with a year-to-date gain of 3.6 percent. Four of the ETF's top-10 holdings have posted double-digit returns this: Procter & Gamble, PepsiCo (NYSE:PEP), Mondelez (NASDAQ:MDLZ) and CVS Caremark (NYSE:CVS).
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All that has the staples sector looking pricey on a valuation basis. In late January, consumer staples rated as the most expensive of 10 sectors trading at 3.4 times book value.
That is on a global basis. As of March 21, XLP had a P/E ratio of nearly 17 and a price-to-book ratio of nearly 3.7, according to State Street data. Those valuations may seem frothy, but investors looking for emerging markets staples exposure are going to encounter even richer valuations.
Take the example of the iShares MSCI Mexico Capped Investable Market Index Fund (NYSE:EWW). Clearly, EWW is not a sector ETF. Tracking Latin America's second-largest economy means the ETF focuses on more than just staples stocks. However, among country-specific emerging markets ETFs, EWW has the largest allocation to staples stocks at almost 29.6 percent.
While recent reform initiatives bolster the long-term bull case for EWW and Mexican equities, there are other issues to consider. Mexico recently lowered its benchmark interest rate to four percent, but inflation was 3.55 percent in February. That is fairly benign, but it also implies real growth rates (interest rates minus inflation) are not jaw-dropping.
Additionally, EWW is richly valued relative to the broader emerging markets universe. The ETF has a P/E ratio of 26.34 and a price-to-book ratio of 3.83, according to iShares data. The iShares MSCI Emerging Markets Index Fund (NYSE:EEM) has a P/E of about 18.4 and a price-to-book of three.
EWW is not the only example of a richly valued emerging markets ETF with a staples bias. The EGShares Emerging Markets Consumer ETF (NYSE:ECON), which has followed other diversified emerging markets ETFs lower this year, is not a staples-specific fund. However, ECON is close.
Beverage makers and food and drug retailers combine for 31 percent of ECON's weight. Food producers garner another 14 percent while tobacco and personal goods makers combine for another 7.4 percent.
South Africa, Brazil and India, three countries that combine for over 46 of ECON's weight, have been drags on the ETF this year. For the privilege of all that, investors get a trailing P/E of 23 and a price-to-book of 3.64.
TheEGShares Emerging Markets Domestic Demand ETF (NYSE:EMDD) debuted in August 2012 and can already be counted among the pricey global staples ETFs. EMDD devotes 57 percent of its weight to China, India, South Africa and Brazil. In particular, the weights to China and India have the potential to make EMDD a compelling long-term play on the expectation that Chinese and Indian consumer spending could top $10 trillion by 2020.
However, that quartet of developing markets have struggled in 2013. Of the four largest ETFs tracking Brazil, China, India and South Africa, the best performer this year has been the iShares MSCI Brazil Capped Index Fund (NYSE:EWZ), which is off more than six percent.
Investors will pay up with EMDD, which has a P/E ratio of 19.2, according to EGShares data.
Ultimately, it can be said that it is not surprising that emerging markets ETFs with heavy staples exposure are more richly valued than their U.S.-focused equivalents. In a more a sanguine environment for developing world equities, investors might still be willing to pay up for added growth and out-performance. This year, however, the returns have not justified the added risk nor the frothy valuations of emerging markets ETFs with significant staples exposure.
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