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Consumer Discretionary Sector Rating: Marketperform

By Brad Sorensen

Consumer discretionary sector overview

The outlook for American consumer spending appears to us to be solid, with consumer confidence still 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, while growth in wage gains has been tough to come by.

Market outlook for the consumer discretionary sector

The consumer discretionary sector has been hit over the past couple of weeks, as apparent concerns over rising costs due to higher tariffs on imports from China may be weighing on sentiment. Additionally, recent retail sales data has been less than inspiring, showing a decline in April for the second month in three. According to the Census Bureau, retail sales fell 0.2%, while excluding the more-volatile autos and gas components, sales also fell 0.2% month over month. The weak data is somewhat surprising given the apparent healthy status of the consumer, and could point to some measurement problems as consumers shift the ways they shop. However, we do think there are still some challenges—not the least of which is the recent rise in oil prices—facing the retail environment, and 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 relatively 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 April, according to the Bureau of Labor Statistics—in line with the previous month’s reading and continuing the recent trend of modest, but not accelerating wage growth. While that may be frustrating to some workers, an advantage is that wages are still not growing fast enough in our view to prompt the Federal Reserve to come off its recently more dovish stance. Continued low interest rates support consumer borrowing and spending, and the April reading for the Conference Board's Consumer Confidence Index® continued to be elevated, bouncing back to 129.2.

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 as we’ve seen recently, 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 March reported that when asked what their biggest problem was, small business owners continued to list finding quality labor 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 April by the Census Bureau showed that department store sales were down 4.0% versus the year-ago period, while non-store retailers (online) rose a solid 10.4%, 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, 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.

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.
  • Fed rate hikes: Although the Fed expects zero rate hikes in 2019, according to its “dot plot” projections, higher inflation could force policymakers’ hands. If this occurs, higher interest rates and a tighter monetary policy 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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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.

NFIB - Single Most Important Problem: question posed in the NFIB (National Federation of Independent Business) Small Business Optimism Survey which is based on the responses of 740 randomly sampled small businesses in NFIB’s membership, surveyed monthly.

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