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Rethinking Consumer Staples

Is the dip in the sector a buying opportunity or a chance to bail out?
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For the past five years, defensive consumer stocks have been good names to own. Many stocks in this sector have appreciated sharply while paying substantial dividends. Should we use the current dip in this sector as a buying opportunity?

We keep hearing from economists and from the Federal Reserve that the economy is about to take off. If this is true, we're at a point in the cycle where investors normally sell defensive names in favor of more aggressive plays. If growth truly is about to explode, money should be rotating away from this sector.

Why does this happen? In an economic downturn, consumers continue to buy food, soap and other necessities. This makes the consumer staples sector somewhat immune to a downturn. But the other side of the equation is also true; in a strong economy, people won't necessarily consume more of these products.

The technicals of many consumer staples names look very similar. This leads me to believe that they aren't being judged on their individual merits, but are being traded as a group. Someone out there believes the economy is recovering and is rotating out of these stocks.

Look at Kimberly-Clark (KMB), one of the best-performing names in this sector. It reached a new all-time high in mid-July, but since then has come crashing down on high volume, breaking through key support levels and moving averages.

Now check out similar-looking charts for Colgate-Palmolive (CL) and Kraft Foods (KRFT).

Because these stocks have rewarded investors generously, there will be a temptation to buy the dip. Not so fast -- all three names reached multiyear highs in July, and all three are now trading below their respective 200-day moving averages (red). And all three sold off on heavy volume.

The names in this sector tend to pay healthy dividends, which is another factor that may work against them. If the economy is truly recovering, then higher interest rates are on the way. That should provide yield-seeking investors with alternatives to dividend-paying stocks.

When stocks fall apart this badly and this quickly, they rarely bounce right back. When numerous stocks in a sector are behaving this way, it's a sign that money is flowing away from that sector as a whole. Unless and until we see some stabilization, don't be tempted to buy consumer-staples stocks.

Charts by TradeStation

At the time of publication, Ponsi had no positions in the stocks mentioned.