Consumer Discretionary Sector Rating: Marketperform

Consumer discretionary sector overview

The outlook for American consumer spending appears to us to be solid, 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 February retail sales report from the Census Bureau showed a decent 4.0% year-over-year gain. Additionally, as mentioned, we’re seeing wages increase in a growing number of areas. Average hourly earnings have risen 2.7% over the past 12 months, according to the Bureau of Labor Statistics—up from the 2.6% seen the previous month but still in what could be considered a sweet spot of modestly growing wages but not growing fast enough to prompt the Fed to pursue more aggressive tightening. Continued low interest rates support consumer borrowing and spending, and the March reading for the Conference Board's Consumer Confidence Index^® fell modestly from an 18-year high to 127.7.

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 March reported that when asked what their biggest problem was, small business owners continued to list finding quality labor as their single biggest problem, taking the top spot away from 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 February by the Census Bureau showed that department store sales were flat over the year ago period, while non-store retailers (online) rose a solid but slightly lower 10.1%, continuing a trend of recent year-over-year data showing 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.

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:

• Friendly 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 generally improved, which should continue as the labor market remains quite tight.
• Tax cut:  The majority of Americans are receiving a tax cut in 2018, which could help to boost consumer spending on discretionary items.

Negative factors for the consumer discretionary sector include:

Clients can see our top-rated stocks in the consumer discretionary sector.

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