Consumer Discretionary Sector Rating: Marketperform

What is the consumer discretionary sector?

It includes automotive, household durable goods, leisure equipment, textiles and apparel, hotels, restaurants, and consumer retailing and services.

Consumer discretionary is—unsurprisingly—one of the more cyclical sectors. As the name implies, it’s dominated by companies that produce products and services that consumers often do without when they are under financial stress or worried about their job security, such as new clothes, new cars or entertainment. The sector has a number of industries with a high degree of exposure to the COVID-19 business shutdowns and shelter-in-place orders that have been under sharp pressure—particularly the hotels & leisure, autos & auto components, and apparel industries. However, those industries are counterweighted by the internet retail industry—Amazon, in particular—which constitutes the about 40% of the sector’s market cap.

The fundamentals for the sector remain challenged, but beaten-down earnings and sales expectations have begun to stabilize—and even improve in some areas. Despite this, however, we judge the fundamentals to be neutral at best, given the renewed spike in new COVID-19 cases and uncertainty regarding any enduring change in social distancing that could fundamentally impact consumer products and services over the long term.

The valuation factors we assess are negative for the sector, as an average of multiple indicators ranks Consumer Discretionary near the bottom of the pack. Much of this can be attributed, once again, to the internet retailers—but also due to the low earnings expectations for other hard-hit areas of the sector. However, given the massive dislocations in the economy, these factors may be of little use.

Despite the recent sharp pullback in those industries most affected by COVID-19, the overall sector continues to outperform the market, due to strong gains in the e-commerce space. While relative strength remains positive, which is consistent with the sector’s pro-cyclical nature and positive macroeconomic score, the recent softening in economic optimism along with the potential that the sector leaders have become overbought argues against chasing the market. We currently maintain a marketperform rating for the Consumer Discretionary sector.

Keep in mind, however, that sharp volatility in the markets, earnings expectations and the economy makes assessing valuations and fundamentals difficult.

Sector Overview: Consumer Discretionary 

Note: Each of the sector lenses shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or central bank policy changes.  

Source: Charles Schwab, as of 07/16/2020