BUYING a good business at an inflated valuation is a poor investment. For most of the last three years we have talked about the stretched valuations of many businesses in the staples sector, where the appreciation in share prices appeared more related to a comparison to bond yields rather than any improvement in their earnings outlook.

The tide has now turned. Global economic growth has persisted and there is less requirement for central banks to buy bonds to depress interest rates.

The US Federal Reserve has turned from a net buyer of bonds to a net seller and the European Central Bank (ECB) has reduced its bond buying. The combination of these factors has led to a fall in bond prices and rise in yields. This process towards normalisation still has some way to go.

Read more: Graham Campbell - How to separate investment from speculation when it comes to Bitcoin

There are expectations that the Fed might hike interest rates up to four times this year, followed by another four times next year. While the ECB is quite a bit behind, growth in the eurozone is strengthening and there is potential for a rate rise towards the end of 2018. We would expect this scenario to maintain downward pressure on bond prices.

As this was unfolding, the staples sector began to underperform the wider market towards the end of 2016. It continued to do so in 2017 as well as this year to date. Some of this underperformance can be attributed to disappointing results from the underlying businesses.

While some market participants think the underperformance has run its course, we believe it is only the beginning of a longer-term trend. Competition remains fierce and we expect earnings growth to remain subdued while the shares are often still on demanding valuations.

Valuation is not the only obstacle holding us back from investing in this space at present. We have said for a while that the dividend yields on staples are not sustainable. Specifically, we have highlighted Coca-Cola for the last two years as an example where the dividend pay-out ratio has reached unsustainable levels and where shareholder returns went hand in hand with increased leverage.

Coca-Cola is not alone in adding leverage. Across the staples space, net debt has tripled since 2009, while the rest of the market actually deleveraged.

Part of this increased leverage was used to return money to shareholders via dividends or share buy backs, which boosted earnings per share. However, some companies also increased borrowings to acquire businesses at arguably stretched valuations in order to bolster underwhelming top-line growth.

Read more: David Keir - Are defensive shares a safe haven or an expensive bubble?

Extended leverage ratios can be accommodated in cash-generative businesses, but cash generation within staples has slowed in recent years.

When interest rates rise and companies have to refinance their relatively stretched balance sheets at higher rates, there will be an impact on earnings and cash flow. It is possible that dividends will be under pressure.

All this is happening at a time when the fundamental backdrop for fast-moving consumer goods (FMCG) companies has deteriorated. We have long argued that top-line growth expectations are optimistic. The average sales growth over the last ten years was five per cent. However, this was inflated by the emerging markets boom in the early 2000s.

Many companies are experiencing increased competition from niche players that are more nimble and better attuned to consumer needs and wants. In particular, e-commerce is offering greater choice to consumers and negating economies of scale.

Read more: Bettina Edmondston - It may have lagged the US, but that's what makes Europe attractive

When volumes are persistently low, especially in developed markets, and when pricing power is eroding, revenue growth comes under pressure.

The combination of increased leverage, still elevated valuations and a subdued growth outlook, means it is still too early to reinvest in the staples sector.

Bettina Edmondston is a global analyst at Saracen Fund Managers.