Written by Tyson Ray, FORM Wealth Advisors | CFP®, CExP®, CIMA®
What happens in the first hour of your life when you wake up? If you’re like me, you have a routine. The other day, as I went about my morning routine, I was trying to figure out all the companies that are involved in the first hour of my life each day.
I wake up with an alarm clock. That’s a piece of technology that a company manufactured. I turn on a light. There’s a company that created the light switch, the wire and the bulb. The light bulb is especially important because if that little bugger goes out, I have to replace it. And the utility company provides electricity to power all the lights my house. The gas company provides the gas that fuels my HVAC system for air conditioning and heat.
The iPhone I reach for is manufactured not just by Apple but also by its contract manufacturers, including Foxconn, Pegatron and the Tata Group. The apps I use are produced by a myriad of different companies.
And then I’ll brush my teeth. There’s a company that made my toothbrush and another that made my toothpaste. The vitamins and medications I take are all manufactured by various pharmaceutical companies. The soap and shampoo I use in the shower were manufactured by different companies. The clothes and shoes I take out of my closet were produced by still other companies.
I make coffee in the kitchen. Various companies harvested the coffee beans, packaged them for sale, manufactued my coffee maker and made my cup.
So, in the first hour of my life, I have used products made by 20 or 30 different companies that produce products or services I cannot live without. If something happened that caused one of those companies to go out of business, I would hope that another company would emerge in its place.
Like me, millions of other people — maybe even billions — rely on similar products and services every day. And we will continue to do so in the the future. There is consistency in the need for these products. We tend to forget that when we are blasted with thhe constant fear-mongering in news and the constant fluctuation of investments.
Consumer staples vs. consumer discretionary stocks
What we are talking about here are “consumer staples” — stocks of companies that create products considered essential by consumers. Stocks in the consumer staples sector include thoses of companies that produce food, beverages, household goods and personal hygiene items. These items are noncyclical, meaning that they typically remain in demand, regardless of economic conditions.
Consumer staples are characterized by steady but seldom spectacular growth. For this reason, this sector can be a haven for investors in recessionary times. Consumer staples stocks can be a good option for investors who are seeking low volatility, consistent growth and solid dividends.
Consumer discretionary stocks, on the other hand, represent companies that sell “wants” rather than “needs.” Companies in this sector produce products such as vehicles, fast food and specialty retail goods. These are items most of us would stop using if we faced an economic burden and had limited funds.
These stocks are considered to be cyclical because their performance is sensitive to changes in consumers’ disposable income caused by economic cycles. Consumer discretionary stocks can be risky investments because they can suffer when the economy contracts. Also, they have what’s called “highly elastic demand,” which means that more expensive goods can be easily replaced by less expensive alternatives. Consumer discretionary stocks are exposed to supply-chain disruptions and tend to have modest profit margins that make them sensitive to inflation.
Risk-on vs. risk-off
When choosing whether to invest in consumer discretionary stocks vs.consumer staples, we really are comparing levels of risk.
Discretionary stocks are considered risk-on because they are more aggressive and are considered an offensive play during the good times, when consumers spend for enjoyment. In contrast, staples stocks are considered risk-off because they are more conservative investments tailored to economic downturns, when consumers tend to purchase only necessities and forgo the “nice-to-have” items.
Consumer staples: A “safer” investment
Regardless of which part of the market cycle we find ourselves in or what shape the economy is in, investors typically have funds allocated to consumer staple stocks. They are some of the safer investments you can have.
In fact, consumer staples have outperformed the S&P 500 during all three recessions so far in the 21st century. Having consumer staples in your portfolio gives you some stability that you won’t get from high-growth, high-volatility sectors like technology. However, depending on your unique situation and goals, we need to determine an appropriate balance of growth stocks vs. “safer” stocks in your portfolio.
When the economy is booming, however, you won’t see many of the more aggressive investors buying stocks in this slower sector. Instead, they are typically looking to take on a higher level of risk, in an effort to gain greater potential rewards. Investors who are looking for rapid earnings growth are unlikely to find it in consumer staples. Other risks such as potential fluctuations due to demographics and product trends, pricing, fads, environmental factors, government regulation, consumer confidence and the cost of the commodities can also factor into the performance of these companies.
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As always, I encourage you to build a strong relationship with your financial advisory team, built on mutual trust, to determine which stocks are appropriate for you at which times. And just remember, those products and services you will always need, those you use in your morning routine — regardless of what’s happening in the world — can build stability into your portfolio and help you hedge volatility.
In other words, invest in the companies that provide the products and services you use every day!
