DEFENSIVE stocks have performed strongly over the last few years. This is especially true for consumer staples including food, beverage, household and personal care companies such as Nestle, Unilever, Coca-Cola, Colgate and Kimberly-Clark.

One of the main reasons behind the strong performance is that investors who rely on a steady income from their portfolios had to shift from bonds into what we call bond proxies.

The yield requirement could not be met with traditional bond investing so we have seen a shift into equities that pay reliable dividend payments, and consumer staples companies do just that.

The large inflows have substantially driven up these companies’ share prices over the last five years. In fact, the price performance is very strongly correlated with the inverted bond yield.

However, the underlying fundamentals of these shares paint a very different picture. Organic growth rates are slowing, both in the food space, but also in household goods and personal care products.

In the early 2000s these companies posted ten to 15 per cent organic growth in emerging markets and two to five per cent in developed markets.

In the recent past these growth rates have slowed to around per cent and zero to one per cent respectively.

The low hanging fruit for staples in these markets has been picked and there is a move among consumers away from multinational big brand products towards local, smaller offerings.

One driver behind the lower organic growth rates is the decline in volumes, both in emerging and developed markets. This in turn is due to consumers switching away from multinational products.

In emerging markets the trend is towards locally produced niche products, especially in personal care. In developed markets private label continues to gain market share from branded manufacturers.

Additionally, in high inflation countries such as Brazil, where the multinationals have had to increase pricing substantially in order to offset the currency impact, a loss in sales volume has been triggered.

In recent months the volume loss has been higher than price increases resulting in negative organic growth rates.

Even in the UK we have seen attempts to push through large price increases in the wake of the fall of sterling after the Brexit vote. The spat between Tesco and Unilever over the pricing of Marmite or the “wider valleys” of Toblerone are cases in point.

Furthermore, staples companies have benefitted from a decline in raw material prices over the last two to three years.

Although margins have improved by about 200 basis points in the last ten years, this equates to an average margin increase of 20 basis points per annum. In future, we expect raw material prices to rise and become a headwind hampering the already pedestrian margin expansion we have seen over the last ten years.

Raw material prices are just one factor that will contribute to rising inflation. We also see labour costs rising on a global basis.

This will automatically lead to pressure on staples companies to increase pricing. However, as mentioned earlier, pricing often results in lower volumes and often the negative volume decline is higher than the positive pricing effect.

In our opinion there are many headwinds on the horizon for these staple companies, not least a recovery in bond yields.

At current hefty valuations the risk of a continued correction and money being pulled out of bond proxies is high.

We are therefore happy to avoid these shares for the time being.

On the other side of the trade we are more positive on cyclical companies that will benefit from rising yields.

We see value in the financial sector as well as in companies benefiting from infrastructure spend.

Bettina Edmondston is a global investment analyst at Saracen Fund Managers