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Our Outlook for Consumer Defensive Stocks

The consumer defensive category offers value and stability in a volatile market.

Morningstar Analysts, 09/28/2011

--Wide economic moats will be more important than ever in the consumer defensive space as the global economy slows again.

--Amid market turbulence and uncertainty, the consumer defensive sector offers relative stability.

--Break-ups, not takeovers, may dominate the headlines over the coming months, as activist investors have led a charge toward creating value in the consumer staples space.

Wide economic moats will be more important than ever in the consumer defensive sector as the global economy slows again.
Although we've been optimistic about the resiliency of our consumer defensive coverage universe over the first nine months of the year, we've still remained cautious about the significant macroeconomic headwinds facing these companies and held steady in our belief that the U.S. was poised for a multi-year period of anemic growth.

Retail sales have continued to hold up quite well--year-to-date same-store sales across our coverage universe are up an average of 5% through August--but in recent months, we've seen price increases from consumer goods manufacturers overtake transaction growth as the primary top-line driver for most retailers.

GDP growth slowed in the second quarter (up only slightly from the revised first-quarter number), and the employment situation hasn't improved in the last three quarters. Meanwhile, the average gasoline price at retail is up 32% year-over-year (to $3.58 per gallon), which has also undoubtedly placed additional pressure on consumers.

Finally, elevated fears surrounding fiscal austerity measures in Europe and domestically suggest that it will be more difficult for consumer goods firms to accelerate growth at a time when an increased number of consumers may be paring back spending.

Sentiment among low-income consumers, the lifeblood of consumer staples volumes, depends heavily on employment. Unfortunately, unemployment still sits above 9% (at 9.1%) in the U.S., and the U-6 or "underemployment" rate is hovering near 16%. The unemployment rate for those with less than a high school diploma has increased 1% even as the rate for the entire population has fallen. In the near term, our outlook is even bleaker. More than 3.5 million Americans receiving extended unemployment benefits will see eligibility roll off during the coming months, potentially putting a dent into an already cash-strapped consumer at the low end of the spectrum. With the U.S. government already running at a deficit of $1.4 trillion, we're skeptical that benefits eligibility will be extended past the current 99-week period. Additionally, we've seen a number of states recently curb the maximum number of weeks that jobless workers can receive unemployment insurance to less than 26 weeks.

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