By Daniel White, Senior Research & Strategy Manager
Could some 'Teddy Bear' stocks give you a nasty nip?
When the lights go out, investors clasp tight to their chests any stocks which helps them sleep well at night. These “Teddy Bear” stocks can most easily be found in Consumer sectors selling everyday items, such as drinks, food or pills to cover our daily needs. We have need of them whatever the economic storms are. The “lights going out” in economic terms can be seen in the rate of interest which central banks set. Following the Great Financial Crisis, interest rates stood at 0.25%, the lowest continuous rate in US history, the Great Depression’s trough rate of 1.5% counting as a feast in comparison. It has been dark, indeed. As a result, Consumer stocks have soared. However, over the past three years, the Fed has seen the glimmer of dawn and started the most feeble and shallow attempt to raise rates in the post Bretton Woods era.
This long spell of low rates was seen as a necessary part of the cure to a tottering financial system and depressed demand. It did the job. The crisis passed and tills started ringing again, but the lowest rates ever seen have both pushed and pulled corporate debt levels upwards. The push comes from yield hungry investors, starved of normal rates of return, who clamour for greater cash to be given back to shareholders. The pull comes from the lure of lowly priced debt, tempting management to buy back shares and make acquisitions. If you give more of your cash back to shareholders, then there is less in the kitty to re-invest in your business. Everything else being equal, levels of capex (capital expenditure) should have fallen.
Now at the level of the whole market (aggregating all the data of the underlying stocks in the S&P 500 as a proxy for the market) our analysis shows that skimping on capex has not happened. If you look at the graph below, S&P 500 ex-financials levels of capex have bobbled around a pretty similar rate to that of pre-crisis.
This is simply because “everything else” has not been equal. Large US corporates are the latest in a long line trying – and failing – to have their cake and eat it. When you up the dividend and ramp up share buybacks whilst still pumping the cash into capex, something has to give. What breaks are previous debt records; last year’s corporate debt levels breaking the previous record set in 2007.
If you take the lift down one floor from the market to the sector, you do see signs that higher cash returns to shareholders have come at the expense of capex. This is particularly true in these Consumer stocks which bring such comfort when anxiety strikes.
This along with acquisitions has led to rising levels of debt in the Consumer staples sector. Over the last decade, the steadier the cash-flow, the greater the debt burden loaded on the plough horse. By comparison, debt levels in volatile materials and energy sectors have stayed comparatively tame.
If you go down further to the ground floor and look at individual stocks, then you can find companies such as Lowe’s, a home improvement retailer, which fit this caricature of over-distribution perfectly: capex levels falling, cash gushing back to shareholders and rapidly rising debt levels.
The end of last year saw investors in great need of comfort as the S&P 500 fell by the greatest amount since the Great Financial Crisis. The instinct is to clutch indiscriminately at the closest “Teddy Bear” sector or stock. When choosing defensive stocks to buy into Canada Life Investment’s Global Portfolios, we sidestep the most heavily debt-burdened names to ensure that our stocks hold lower levels of debt than the wider market. As yield curves invert and many investors fret about the timing of the next recession, choose your bear carefully. If it carries too much debt, it might give you a nasty nip.
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CLI01418 Expiry 30/06/2019