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Defensive actions take their high-flying turn

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The threat of stagflation in the United States is causing investors to treat supermarkets and other consumer staples companies like the high-flying tech stocks of yesteryear. Stocks have beaten consumer discretionary peers by the widest margin in two decades, and the outperformance likely has room to continue.

The reason is understandable, given the economic context. Investors fear the effect slowing growth is likely to have on discretionary spending and are also petrified of what 40-year high inflation means for fixed income and cash. So many people have settled for a strategy focused on so-called defensive stocks — which include utilities and healthcare in addition to household goods — and it has worked so far.

Staples have been stars. The broadest index of consumer staples stocks in the S&P 500 is up 12% over the past 100 trading days, while discretionary stocks are down 18%.

In a downturn, core stocks usually end up pulling back, but not as much as other sectors. But most pessimists believe that a US recession – if one occurs – is more likely to occur in 2023 or 2024. Staples rode through about the first half of the Great Recession before finally fading.

Of course, not all commodities are created equal, and their differences could become increasingly significant as concerns grow that the Federal Reserve’s fight against inflation could tip the economy. in the recession. The rich will continue to spend on high-end products. But average incomes could well fall, especially as further price increases occur for everyday items. Procter & Gamble Co., Nestlé SA and Unilever Plc warned of further increases in the coming months.

One of the proven mechanisms for coping with inflation is to abandon more expensive private label products for cheaper private label products from supermarkets.

That didn’t show up much in first quarter earnings, although Dove soap and Ben & Jerry’s Unilever ice cream maker saw the amount of goods sold fall. But private label sales are starting to gain traction, according to data provider IRI. If this trend gains momentum, it could potentially reduce the volume of sales of Nespresso coffee capsules from Nestlé SA or Pampers diapers from P&G.

Although this may be a concern for large manufacturers, supermarkets known for their low prices, such as Walmart Inc., Costco Wholesale Corp. and Target Corp., could be the beneficiaries.

Other winners include dollar stores and the U.S. arms of German discounters Aldi Einkauf SE and Lidl, part of Germany’s Schwarz Group, which are expanding through the U.S. Dollar General Corp. and Dollar Tree not only offer cheap merchandise, but their pricing systems help budget consumers with their mental math before they hit the register, as our Bloomberg Intelligence colleague Jennifer Bartashus pointed out. These days they are much more like supermarkets than just cheap retailers, with a wide range of groceries. The trend of digital coupons on TikTok — essentially influencers showing consumers how to combine coupons for big savings — is also driving free advertising.

As investors favor commodities, it has become popular to shed stocks exposed to low-income consumers, as they spend a higher proportion of their income on food and fuel. Therefore, according to the thesis, they will be disproportionately affected by rising prices.

But that misses a key point. While some loyal shoppers will have to pull the purse strings and shop less at discount chains, these retailers could benefit from lower prices from higher-income consumers. Therefore, any loss of sales from traditional customers should be compensated by an influx of new buyers. Walmart said in February that all consumers — even the wealthiest families — become more price-sensitive during times of inflation.

The greatest danger for investors therefore lies not in the bargain basement, but in the happy medium. Some signs of this are already showing.

Clearly, some of Gap Inc.’s problems at Old Navy are on its own initiative — not having enough fashionable dresses and tops as shoppers quickly shift from comfortable to chic, for example. Supply chain bottlenecks haven’t helped either.

But Old Navy is exactly the type of brand that is vulnerable to rivals such as Walmart and Associated British Foods Plc’s Primark, which is opening more stores in the United States and trading well in the region. Although Target’s prices are similar to Old Navy, its fashion is more edgy, which consumers favor when dining out and getting ready for the holidays. TJX Companies Inc., owner of TJ Maxx and Marshalls, could be another beneficiary of stretched budgets.

The bearish trade could also favor the likes of Chipotle Mexican Grill Inc., as Americans trade more expensive takeout or a meal at a fast-casual restaurant for a bargain rate. Although Chipotle raised prices, it encountered little resistance from customers, perhaps because the increases were starting from a low base.

So while investors are right in favoring commodities, the market is likely to get trickier from here; investors may have to be choosy. Businesses discounting essentials may be one of the last refuges if the outlook deteriorates.

More writers at Bloomberg Opinion:

• The FANG and Europe enter into a crisis of expectations: John Authers

• Robinhood’s era of fun and games is coming to an end: Jonathan Levin

• Fed rate hikes won’t pass through to savers: Robert Burgess

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail sectors. She previously worked at the Financial Times.

More stories like this are available at bloomberg.com/opinion