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 relatively stable, 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 solid and hasn’t shown signs of diminishing to any great degree at this point. In fact, the recent retail sales report from the Census Bureau showed a robust 0.6% gain in sales m/m while the previous month was revised to a 0.3 % gain from an initially reported fall of 0.2%.  Additionally, we’re seeing wages increase in a growing number of areas, although the gains aren’t accelerating as quickly as we thought they would with the tight labor market. Average hourly earnings have risen 2.5% over the past 12 months, according to the Bureau of Labor Statistics, while the Atlanta Federal Reserve Wage Growth Tracker shows even better gains of 3.3%. Continued low interest rates support consumer borrowing and spending and the August reading for the Conference Board's Consumer Confidence Index® rose, and remained quite high at 122.9. 

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. Additionally, we’ve seen signs that auto sales, after a solid run, may be starting to rollover, which is something to watch. 

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 fell 3.9% over the year ago period, while non-store retailers (online) rose a robust 11.0%, continuing a trend we’ve seen recently. 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 will likely continue to raise short-term interest rates, future increases are expected to be slow and gradual, which should allow consumers to absorb them relatively easily. 
  • 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 remains quite tight.

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.

Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare.

Schwab Sector Views

Consumer discretionary

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