Consumer staples vs. consumer discretionary

Key Points

• In falling stock markets and weak economic climates, the term "consumer staples" became more familiar in the media.
• In rising bull markets and expanding economic climates, "consumer discretionary" tends to get thrown around more often. 
• What's the difference? Learn more about consumer staples vs. consumer discretionary.

Consumer staples and consumer discretionary have one thing in common: they affect consumers. Consumer staples become more familiar in the media in falling stock markets and weak economic climates. In rising bull markets and expanding economic climates, consumer discretionary tends to get thrown around more often. 

When you hear the phrase consumer staples vs consumer discretionary, what does it mean? What does it mean when investors have to decide between consumer discretionary vs. consumer staples stocks in their investment portfolios? 

By the end of this article, you will be able to ascertain the differences between the two and how they react in different market conditions. 

What are consumer staples?

Consumer staples are items considered essential to daily life and purchased regularly. If your money was gone, what goods do you need to survive? 

You'd need food, beverages, personal hygiene products, household items and other necessities. 

Consumer staples stocks are the companies that produce these products. They are considered conservative investments that are stable in weak economic climates since people still need these items most to go about their daily lives. 

Examples of companies that produce consumer staples products 

Consumer staples companies are widely known household names that consumers know as they commonly shop for those items. The Proctor & Gamble Company NYSE: PG is one of the most prominent consumer staples manufacturing consumer brands, which manufactures goods for beauty, grooming, healthcare, baby and feminine care products. The company produces shampoos, diapers, shaving products, toothpaste and household items like laundry detergents and dishwashing liquids. 

Another well-known consumer staples company is Campbell Soup Co. NYSE: CPB, which produces nonperishable food items, including soups, snacks and beverages. Kellogg Co. NYSE: K manufactures ready-to-eat cereals and convenience foods like cookies, crackers and chips. 

Consumer staples stocks also include wholesalers and stores where consumers purchase such items. The Kroger Co. NYSE: KR operates grocery stores where consumers shop to buy consumer staple items. Costco Wholesale Co. NASDAQ: COST is one of the largest warehouse club stores in the world where consumers can purchase consumer staples items in bulk. 

What is consumer discretionary spending? 

Consumer discretionary refers to goods and services that are luxury or nonessential items purchased for entertainment, leisure or pleasure. These are the things people buy when they have extra discretionary income to splurge on themselves or with friends, including optional items like consumer staples, such as apparel, electronics, travel, dining out, champagne, vacations, video games, toys and entertainment. 

Consumer discretionary is more sensitive to economic downturns as consumers can quickly tighten their wallets during high inflation, unemployment and economic uncertainty.

Examples of companies that produce consumer discretionary

Consumer discretionary stocks are companies that produce and distribute discretionary goods. High-end apparel manufacturers like Ralph Lauren Co. NYSE: RL and PVH Corp.NYSE: PVH, Cavin Klein and Tommy Hilfiger clothing makers, are well-known consumer discretionary brands. 

Live Nation Entertainment Inc. NYSE: LYV is one of the world's most extensive entertainment companies, operating live music concerts, sporting events, and promotions. Tesla Inc. NASDAQ: TSLA is the luxury electric vehicle (EV) manufacturer that has taken the world by storm, leading to EV adoption trends.  

Differences between consumer staples and consumer discretionary 

There are stark differences between consumer staples and consumer discretionary stocks. Depending on the macroeconomic climate, these differences also determine the kind of investment you may wish to engage with your portfolio.

Level of necessity

Consumer staples have a higher level of necessity than consumer discretionary items. People need food, toilet paper, soap and toothpaste more than a designer handbag, video game system or a ticket to a Taylor Swift concert. During tough economic times, consumers have few choices between buying things they need and something they may want. Buying food takes priority over buying video games. In total economic boom times, consumers have the disposable income to purchase nonessential or luxury items for pleasure and entertainment. 

Risk on or off

The difference between consumer discretionary versus staples stocks boils down to the investor sentiment of putting risk on or taking risk off the table. Discretionary stocks are risk-on, as they are more aggressive and considered an offensive play during boom times when consumers spend for enjoyment. 

Staples stocks are considered risk-off, as they are more conservative investments tailored to economic downturns where consumers have tightened their wallets to purchase only necessities during uncertain times. 

Price multiples

Consumer discretionary stocks tend to be more aggressive and carry higher price multiples since growth is an element of its pricing. Expect to pay higher prices for higher valuations for these stocks, especially technology stocks. During economic growth periods and bull markets, consumer discretionary stocks tend at higher multiples as they gain momentum on top-line growth. High inflation also tends to inflate asset values, further driving discretionary stocks higher in the near term. 

The consumer price index measures the rate of inflation. A rising CPI equates to high inflation triggering interest rate hikes which cause discretionary stocks to fall as investors look for risk-off investments in consumer staples stocks to protect their capital. However, all good things end when interest rates get too high. The U.S. Federal Reserve will decrease inflation by raising interest rates. This is how the consumer price index affects stock market action.

Dividends

Consumer staples stocks tend to offer stable and consistent dividend payments, which adds an income stream benefit when owning these stocks. Dividends help to buffer against stock price volatility during economic downturns. While some consumer discretionary stocks also pay dividends, they usually reinvest the money into the company to prioritize growth through more spending. Dividend Aristocrat stocks tend to be consumer staples, representing stability throughout bull and bear markets. 

Comparative analysis 

Several distinct patterns emerge when comparing consumer staples and consumer discretionary sectors based on performance metrics like revenue, profitability, stability, economic and market influences, and the impact of external factors such as economic conditions and consumer behavior.

Revenue

The revenue growth trajectories of consumer staples and consumer discretionary companies paint contrasting pictures. Consumer staples, purveyors of essential goods, tend to enjoy a more consistent albeit slower pace of revenue expansion. Their products, deeply ingrained in daily life, maintain a steady demand, largely immune to the ebb and flow of economic cycles. In contrast, consumer discretionary companies, catering to non-essential desires, navigate a more volatile revenue landscape. Their sales are highly attuned to shifts in economic conditions and consumer sentiment, often experiencing sharp swings during boom and bust periods.

Profitability and stability

The profitability of consumer staples and consumer discretionary companies diverge significantly. Consumer staples, providers of essential goods, are renowned for their stable profitability. Their predictable cost structure, stemming from well-established supply chains and efficient operations, provides a solid foundation for consistent earnings. Even during economic downturns, when discretionary spending contracts, consumer staples companies often maintain resilient earnings, demonstrating their defensive nature.

In contrast, consumer discretionary companies face a more volatile profitability environment. Their profitability is susceptible to fluctuations in input costs, particularly raw materials, and the intense competitive dynamics within the discretionary market. As consumer preferences shift and new entrants emerge, profit margins can narrow, leading to more volatile earnings performance. This volatility reflects the cyclical nature of the consumer discretionary sector, where profitability is closely tied to the overall health of the economy and consumer spending patterns.

Economic and market influences

The performance of consumer staples and consumer discretionary stocks exhibits distinct correlations with economic factors, mirroring their contrasting characteristics. Consumer staples stocks, purveyors of essential goods, often correlate closely with GDP growth and consumer spending. Their steady demand, fueled by the necessity of their products, translates into relatively stable earnings growth that tends to outpace broader economic growth during periods of economic expansion. 

However, when consumer spending tightens during economic contractions, consumer staples stocks tend to outperform the broader market, demonstrating their defensive nature.

In contrast, consumer discretionary stocks, catering to non-essential desires, strongly correlate with overall market trends and consumer sentiment. Their cyclical nature aligns them closely with the broader economic climate, flourishing during periods of economic expansion when consumer spending is robust. However, when economic conditions deteriorate and consumer sentiment sours, consumer discretionary stocks often suffer disproportionately, reflecting the sensitivity of their sales to discretionary spending patterns.

This contrasting correlation with economic factors underscores consumer staples' and discretionary stocks' distinct investment profiles. Consumer staples stocks offer stability and income potential, while consumer discretionary stocks offer the potential for higher growth during periods of economic expansion. 

Impact of External Factors

The consumer staples and consumer discretionary sectors exhibit stark differences in their sensitivity to economic conditions and consumer behavior. Consumer staples companies are shielded from economic cycles and consumer whims. Their products, deeply ingrained in daily life, maintain a steady demand, largely unaffected by economic fluctuations or shifts in consumer sentiment. This resilience stems from the necessity of their offerings, ensuring a stable customer base that prioritizes essential purchases regardless of external factors.

In stark contrast, consumer discretionary companies, catering to non-essential desires, face a more vulnerable existence. Their sales and profitability are highly susceptible to changes in consumer behavior and economic conditions. Consumer preferences, disposable income, and economic uncertainty play a significant role in shaping their fortunes. During economic expansions, when consumer spending is robust, consumer discretionary companies thrive, benefiting from increased product demand. However, when economic conditions deteriorate and consumer sentiment sours, they often experience steep sales and profitability declines, reflecting their business models' sensitivity to discretionary spending patterns.

This contrasting sensitivity to economic factors underscores consumer staples' and discretionary stocks' distinct investment profiles. Consumer staples stocks offer stability and income potential, while consumer discretionary stocks offer the potential for higher growth during periods of economic expansion. When choosing between these two sectors, investors should consider their risk tolerance and objectives carefully.

Investment considerations

Investing in consumer staples and consumer discretionary sectors demands a nuanced understanding to capitalize on their potential for profitable returns. To navigate these sectors successfully and optimize investment outcomes, various crucial considerations must be explored. These encompass weighing long-term versus short-term strategies, achieving a balanced portfolio through staples and discretionary stocks, and implementing effective risk mitigation and diversification approaches.

Long-term vs. short-term strategies

Understanding the differing characteristics of consumer staples and discretionary stocks is pivotal in aligning investment horizons. Consumer staples, known for stability and consistent earnings, suit long-term strategies, offering resilience during economic downturns. Conversely, the cyclical nature of consumer discretionary stocks favors short-term investors, presenting higher growth potential in economic upswings but heightened risk during contractions.

Balancing a portfolio with both sectors

Creating a well-rounded portfolio entails harmonizing the stability of consumer staples with the growth potential of consumer discretionary. Staples form the bedrock, providing stability and income generation, while discretionary stocks offer growth prospects in favorable economic conditions. Tailoring the allocation between these sectors hinges on investor risk tolerance and objectives, varying between conservative and aggressive approaches.

Risk mitigation and diversification strategies

Mitigating risks which is inherent in consumer goods investments necessitate prudent diversification strategies. To diminish specific sector-related risks, sector diversification involves spreading investments across varied subsectors within consumer goods, such as food, apparel, or entertainment. Geographic diversification further fortifies portfolios, buffering against regional economic fluctuations by investing across diverse global markets.

The intricacies of consumer goods investments require a comprehensive grasp of each sector's dynamics. By researching long-term and short-term strategies, advocating for balanced portfolio construction, and robust risk mitigation through diversification, investors can strategically position themselves to harness the potential offered by consumer staples and discretionary stocks.

Regulatory environment and global factors

The regulatory environment and global economic factors wield considerable influence over consumer staple and discretionary stocks' performance and prospects. Regulatory changes impact these sectors differently: consumer staples face alterations in product safety and environmental standards, potentially affecting profit margins, while discretionary goods may need adjustments in design or marketing strategies, impacting their profitability.

Regarding global economic trends, staples exhibit resilience across economic climates due to consistent demand, thriving during downturns. In contrast, discretionary stocks flourish during economic upswings but face heightened volatility during contractions, mirroring consumer spending patterns.

Looking at cross-border opportunities, emerging markets offer growth potential for staples, driven by rising demand from expanding middle classes. Simultaneously, global e-commerce platforms present avenues for discretionary companies to reach wider audiences, diversifying revenue streams and tapping into new markets.

The future outlook is promising for both sectors: staples benefit from population growth and sustained demand, especially in emerging economies, while discretionary stocks capitalize on increasing disposable incomes and favorable economic conditions. However, both sectors grapple with challenges, including rising costs and market competition, shaping their future trajectories.

Navigating market volatility

Understanding how consumer staples and consumer discretionary sectors respond to economic shifts is paramount before making an investment decision. Let’s look at both sectors and review how they respond to economic changes. 

Consumer staples: Stability amid turbulence

Consumer staples, the essentials like food and household items, exhibit remarkable resilience during economic downturns. Their indispensability ensures a consistent demand, making them less susceptible to fluctuations in consumer spending. During the 2008 financial crisis, the Consumer Staples Select SPDR Fund NYSEARCA: XLP demonstrated robust stability, declining merely by 11.4% compared to the S&P 500's staggering 57% plunge.

Consumer discretionary: Adapting to fluctuations

In contrast, consumer discretionary entities, dealing in non-essential goods like electronics and entertainment, grapple with greater challenges during economic contractions. Changes significantly influence their sales in consumer sentiment and disposable income. However, post the 2008 financial crisis, the Consumer Discretionary Select SPDR Fund NYSEARCA: XLY showcased resilience by outperforming the broader market during the subsequent recovery in 2010 and 2011.

Strategies for risk mitigation

Navigating market volatility within the consumer goods sector involves adopting prudent risk-mitigation strategies:

• Diversification: Balancing investments across consumer staples and discretionary stocks offers stability and growth potential while reducing exposure to sector-specific risks.

• Sector diversification: Spreading investments across diverse subsectors within each segment, such as food and beverage or personal care, minimizes vulnerability to sector-specific risks.

• Geographic diversification: Investing in consumer goods companies with global reach mitigates the impact of regional economic fluctuations. Exploring emerging markets can enhance diversification benefits.

• Active portfolio management: Regular monitoring of market conditions and individual company performance allows for timely portfolio adjustments to maintain the desired asset allocation.

• Quality focus: Prioritizing companies with robust fundamentals—consistent profitability, strong cash flow, and operational efficiency— protects during market downturns.

During economic volatility, consumer staples showcase stability due to necessity, while consumer discretionary stocks face more challenges due to their reliance on consumer sentiment. Employing diversification strategies and focusing on quality companies aid investors in navigating market fluctuations effectively within the consumer goods sector.

Future trends and emerging opportunities

The landscape of consumer goods (both consumer staple and consumer discretionary) is evolving, driven by emerging trends like technological innovation, shifting consumer preferences, sustainability, and burgeoning opportunities in emerging markets.

Technological innovation: Redefining consumer engagement

Innovations in technology are reshaping how companies operate and interact with consumers in both consumer staples and consumer discretionary sectors. Artificial intelligence (AI) and machine learning (ML) are revolutionizing product recommendations, pricing strategies, and customer service, enhancing personalized experiences. E-commerce platforms and Direct-to-Consumer (DTC) models disrupt traditional retail, offering seamless shopping experiences and direct brand-consumer connections.

Shifting consumer preferences: Embracing wellness and sustainability

Consumer inclinations are pivoting towards wellness, sustainability, and ethical sourcing, compelling a transformation in product offerings and company practices. Health-focused consumers prioritize organic, natural, and minimally processed products for their physical and mental well-being. Sustainable practices, including eco-friendly packaging and ethical sourcing, resonate with environmentally conscious consumers.

Consumer staples: Innovating for sustainability and growth

Consumer staples companies adapt by integrating technology and sustainability while seeking opportunities in emerging markets. Personalized nutrition and wellness solutions driven by AI and data analytics address individual health needs. Sustainable packaging initiatives and eco-friendly formulations align with the growing demand for environmentally responsible products. Expansion into emerging markets allows staples to cater to diverse consumer demands and preferences.

Consumer discretionary: Elevating experiences and sustainability

Consumer discretionary firms respond by focusing on personalized experiences, sustainability, and direct-to-consumer strategies. 

Personalized marketing using AI insights and sustainable practices in fashion production meet evolving consumer preferences. E-commerce expansion and DTC models offer consumers seamless, personalized shopping experiences and direct brand engagement.

Emerging opportunities in consumer goods

The consumer goods sector presents diverse investment avenues:

• Personalized wellness solutions: Companies leveraging AI and data for personalized health and wellness are poised for growth.

• Sustainability in packaging: Brands emphasizing sustainable packaging and eco-friendly practices align with the rising demand for environmental stewardship.

• E-commerce and DTC brands: The surge in online retail offers opportunities for brands embracing digital transformation and direct-to-consumer models.

• Expanding into emerging markets: Consumer staples and sustainable discretionary brands targeting emerging markets tap into growing consumer bases.

Investors eyeing consumer goods should focus on technology-driven innovations and sustainability initiatives, explore emerging markets, conduct in-depth analyses and adapt strategies to capitalize on evolving trends. The future of consumer goods hinges on adaptability to changing consumer preferences and leveraging innovation for sustainable growth.

Decoding Consumer Essentials vs. Desires

Understanding the distinctions between consumer staples and consumer discretionary is paramount when considering if you will invest in the consumer goods sector. 

Consumer staples, the essentials of daily life, offer stability, while discretionary items cater to desires, embracing volatility. Deciphering these nuances empowers investors to craft resilient portfolios, balancing necessity with luxury. 

As economic winds shift, staples stand firm while discretionary ventures. Navigating this landscape demands a keen eye on consumer needs, market trends and global influences.