Consumer discretionary sector overview
The outlook for American consumer spending appears to us to be fairly solid, but could be increasingly pressured by growing trade tensions that could raise costs and threaten parts of the labor market. Also, wage growth has been slow in coming, spending at traditional retailers has been trending lower and competition among retailers may limit profitability.
Market outlook for the consumer discretionary sector
The consumer discretionary sector has rebounded a bit from a trade-related pullback, as some earnings results have bested estimates (FactSet), and trade hopes were revived after the announcement of an October meeting between the two sides (Wall Street Journal). The recent tariff increase by the U.S. on China is likely to have a greater effect on consumer goods than previous increases, which could cause a dent in sales. However, recent retail sales data has been better than expected and has shown little impact from the trade tensions yet, with the Census Bureau reporting sales rose 0.7% month-over-month in July, while ex-autos and gas, sales were up an even better 0.9%. The better data is more in line with what we’ve been thinking given the apparent healthy status of the consumer, but that could be changing as consumer goods become more of a target. Additionally, oil prices are down roughly $15 per barrel over year-ago levels based on West Texas Intermediate prices, which should help to offset at least some of the potential rise in costs from increased tariffs, supporting our belief that the discretionary sector should continue to hold a marketperform rating.
Fundamentally, the American consumer continues to look strong to us, with near-historical low unemployment, still low interest rates, and modestly rising wages. Additionally, as mentioned, we’re seeing wages increase in a growing number of areas. Average hourly earnings rose 3.2% during the 12 months ended in August, according to the Bureau of Labor Statistics—a tick lower than the previous month’s reading, which was revised higher, but still continuing the recent trend of modest wage growth. While that may be frustrating to some workers, an advantage is that wage pressures for companies don’t seem to be rapidly accelerating despite the tight labor market—yet. Continued low interest rates support consumer borrowing and spending, and the July reading for the Conference Board's Consumer Confidence Index® continued to be elevated, showing little impact from trade-related issues, ticking very slightly lower to a still-high 135.1 from 135.8.
While the consumer’s status looks fairly positive, at this point in the business cycle—which we view as being in the latter stages—the consumer discretionary sector has tended to perform more in line with the market, as it tends to be an early mover in the business cycle. That doesn’t mean that it couldn’t outperform in the current environment, but we also don’t want to completely ignore historical precedent. Additionally, 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 National Federation of Independent Business (NFIB) survey for August reported that when asked what their biggest problem was, small business owners continued to list finding qualified workers as their single biggest problem.
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 July by the Census Bureau showed that department store sales were down 4.3% versus the year-ago period, while non-store retailers (online) rose a robust 11.9%, illustrating the continuing challenges facing “traditional” retailers as the group continues to “right size” in our view, paring weaker performers from an overcrowded space.
Overall, the American consumer’s mood appears 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 and we see the threat from trade tensions rising, resulting in our marketperform rating.
Factors that may affect the consumer discretionary sector
Positive factors for the consumer discretionary sector include:
- Solid 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 generally improved, which should continue as the labor market remains quite tight.
- Dovish Fed: The Federal Reserve recently cut interest rates and appears to be ready to cut more—potentially making borrowing cheaper and giving consumers more money to spend.
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.
- Trade disputes: As the trade conflict with China intensifies, it could raise costs for American producers and prices for consumers, or compress margins even further.
- 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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|Communications||Consumer discretionary||Consumer staples|