Consumer discretionary sector overview
The outlook for American consumer spending appears to us to be improving, with consumer confidence strong, a tight labor market and wages 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 has shown signs of improving as the labor market remains tight and wages are moving higher. In fact, the September retail sales report from the Census Bureau showed a robust 1.6% gain in sales m/m, although that has to be taken with a bit of a grain of salt as there are hurricane-related distortions involved, but the trend continues to look solid. Additionally, as mentioned, we’re seeing 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, while the Atlanta Federal Reserve Wage Growth Tracker shows even better gains of 3.46%. Continued low interest rates support consumer borrowing and spending and the September reading for the Conference Board's Consumer Confidence Index® rose, and remained quite high at 119.8.
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, 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. In fact, the recent NFIB (National Federation of Independent Business) survey for September reported that when asked what their biggest problem was, small business owners continued to list finding quality labor as their second biggest problem (right behind taxes.)
Meanwhile, the spending mix is shifting, with online sales rising, although at a less rapid rate, while traditional department store sales have been relatively tepid, and the resulting price competition has created a tough environment for many retailers. The retail sales report for September by the Census Bureau showed that department store sales fell 3% over the year ago period, while non-store retailers (online) rose a solid 10.1%, although recent year-over-year data has shown those numbers slowly converging, potentially indicating a balance between online and traditional shopping may be getting closer. 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 of poorly performing retailers, ultimately helping those retailers that do survive. In fact, we may be seeing some reversal in that trend toward online shopping as the Wall Street Journal reported that traditional print books sales have risen at an increasing rate the last three years, while e-book sales have fallen during that period—a small sign of a potential leveling out of purchasing habits. Additionally, in contrast to the much reported demise of retail, Forbes and IHL Group (Forbes, September 11, 2017) reported that it is estimated that while over 10,000 stores are indeed estimated to close in 2017, over 14,000 are expected to open—so maybe retail isn’t quite dead.
American consumers’ mood appears quite positive 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 been raising 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.
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