By Jacob Sonenshine

Consumer staples stocks are on a roll, bucking the broader market's downward trend.

But staples' gains are almost tapped out. It's time to look elsewhere -- unless you're betting on a recession.

The Vanguard Consumer Staples exchange-traded fund -- home to names such as Coca-Cola, PepsiCo, Procter & Gamble, Colgate-Palmolive, and Walmart -- is up just over 5% this year. That trounces the Consumer Discretionary Select Sector SPDR ETF's nearly 7% slide for 2025. That ETF owns more economically-sensitive stocks -- like Amazon.com, Tesla, Home Depot, other retailers, Starbucks and other brands.

The divergence is clear as day. Investors have bought up companies that sell essential products that still see demand in an economic downturn. Meanwhile they have pulled money out of the discretionary names and tech companies whose sales suffer when shoppers pull back on spending.

The main culprit for this trade into the safer staples is President Donald Trump's tariffs on imports from China, Mexico, and Canada. Those levies will force companies to raise prices -- stoking inflation and putting pressure on shoppers' wallets. That would leave less room for discretionary and tech purchases, likely dragging on those companies' profits. But staples should hold up: Those firms can lift prices to deal with rising import costs -- while keeping demand and overall sales relatively steady.

The questions for investors are how much tariffs could stoke inflation, how long the Federal Reserve would keep interest rates higher, and how much the levies could tamp down spending -- and whether the latter could lead to an economic downturn.

"If you think recession is inevitable, then staples are the place for you as a safety trade," analysts at DataTrek write. "If you think the U.S. economy can avoid recession, as we do, then tech is the better group over the next year, as history shows stocks that leverage disruptive innovation tend to outperform over the longer run."

Recession aside, there are plenty of reasons not to buy staples. For one, the sector's outperformance has become so extreme it likely can't continue for much longer. S&P 500 staples have outpaced the index's tech sector by almost nine percentage points in the past year. After one-year periods when staples beat tech by eight percentage points or more, the following 12 months have seen the S&P 500 average a gain -- one that beats the move in staples by 14 percentage points, according to Dow Jones market data.

Along those lines, staples' stretched valuations are another signal of underperformance ahead. The staples ETF trades at 21.6 times aggregate expected earnings over the next 12 months, above the S&P 500's 20.8 times, according to FactSet. Staples can sometimes trade at a slightly higher premium, but not much higher: The ETF's price-to-earnings premium has already moved close to the high end of its range in the past decade. The sector can trade at a discount to the S&P 500 in moments when the market is less concerned about the economy.

Staples' multiple is nearly in line with the discretionary ETF's 23.3 times, after spending most of the past decade trading at a discount to that fund. The same is true for staples' PE multiples versus the tech sector, which trades at only 3.7 points above staples -- a smaller discount versus history.

And don't look to earnings growth to bring staples' shares higher, either. Staples just don't have the same long-term growth potential of other sectors, especially tech. Staple companies' main way of moderately growing sales and earnings is through gradual price increases over time. That's in contrast to tech, which is constantly innovating; that sector often disrupts older business models, takes market share, and rapidly grows earnings -- and in turn, their stock prices climb.

At these prices for staples, investors should turn to tech. The breadth of all of this data show that, after a period when tech, discretionary and the broader market have become cheaper, those groups tend to post the best returns -- as long as the economy remains growing.

Sure, growth will likely slow, but if the economy avoids falling apart, tech and discretionary earnings will still rise -- and their stocks will leave staples in the dust.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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March 07, 2025 14:22 ET (19:22 GMT)

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