Consumer Discretionary Sector Rating: Marketperform
What is the consumer discretionary sector?
The consumer discretionary sector comprises businesses that tend to be sensitive to economic cycles. It includes automotive, household durable goods, leisure equipment, textiles and apparel, hotels, restaurants, media production/services, and consumer retailing and services.
Consumer discretionary sector overview
The outlook for American consumer spending appears to be improving, with consumer confidence strong and wages generally showing signs of trending higher. However, spending on traditional retail items has been cautious and competition among retailers may limit profitability.
Market outlook for the consumer discretionary sector
The status of the U.S. consumer looks to us to be quite solid and is showing signs of improving. There are certainly a number of positives for the discretionary group: Consumers have reduced their debt loads since the Great Recession and the job market is solid. We’re also starting to see wages increase in a growing number of areas. Average hourly earnings have risen 2.5% over the past 12 months, according to the Bureau of Labor Statistics. Continued low interest rates support consumer borrowing and spending and the April reading for The Conference Board’s Consumer Confidence Index® fell modestly, but remained quite high, coming in at 120.3.
So why aren’t we rating the group at outperform? Remember, the performance of the discretionary sector doesn’t always mirror the health of the consumer environment, and the positive factors listed above are counterbalanced by other issues, in our view. For instance, consumers seem to be somewhat reticent to spend on traditional retail items, and underemployment is still a concern. There still appears to be a mismatch between job seekers’ skills and the jobs available, leading some folks to work for less than they would like. Perhaps more important, Americans’ willingness to take on consumer debt appears to have waned. We haven’t seen debt as a percentage of disposable income bounce back in any meaningful way, following a considerable decline after the Great Recession, although there are some indications that this may be reversing somewhat, as noted above.
Meanwhile, the spending mix is shifting, with online sales rising while traditional department store sales have been relatively tepid, and the resulting price competition has created a tough environment for many retailers. The recent retail sales report by the Census Bureau showed that department store sales actually fell 6.6% over the year ago period, while non-store retailers (online) rose a robust 11.2%. And anecdotally, we’ve seen an increasing number of “traditional” retailers note either slowing sales growth or falling sales, or that they’ve had to shut down business altogether. Contrary to popular opinion, however, we believe this is helping to “right size” the retail industry that had overcapacity, ultimately helping those retailers that do survive.
American consumers’ mood has certainly improved and we’ll be watching to see if that translates into more spending and more pricing power for retailers. For now, we believe that companies in the extremely competitive sector will still be fighting for every dollar, resulting in our marketperform rating.
Factors that may affect the consumer discretionary sector
Positive factors for the consumer discretionary sector include:
- Accommodative monetary policy: Although the Federal Reserve has raised short-term interest rates again, future increases are expected to be slow and gradual, which should support consumer borrowing and spending. Central banks in other developed markets appear to be firmly in an easing stance
- Improving job market: The U.S. unemployment rate is low and initial jobless claims continue to indicate further growth in employment.
- Wage growth: Wage growth has improved, which should continue as the labor market tightens.
Negative factors for the consumer discretionary sector include:
- Fierce retail competition: Exacerbated by the shift toward online shopping, this appears to be affecting margins, which could spill over into problems for stock performance if the trend accelerates.
- Faster-than-expected Fed rate hikes: If this occurs due to increased inflation concerns, higher interest rates could be a hindrance to the consumer discretionary sector.
- Changing consumer: There are strong indications, such as the recent retail sales report, that consumers, especially millennials, have different spending habits now than they did before the Great Recession.
Clients can see our top-rated stocks in the consumer discretionary sector.
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The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.
The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.
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