Consumers drive the economy—a lot of it, anyway—personal consumption expenditures make up about 70% of GDP. And when the good times roll, the consumer discretionary sector tends to be their happy place. The sector’s double-digit performance last year and high single-digit year-to-date showing reflect the revelry that it’s been for consumers, many of whom appear to be basking in the high life.
But how long can this party continue? Not much longer, according to some industry analysts.
A deeper look into the sector shows major shifts in spending that industry watchers often refer to as “disruptive” of the traditional retail business model. The sector comprises businesses that sell cars, household durable goods like computers, furniture, and appliances, leisure equipment, textiles and apparel, hotels, restaurants, media production and services, and consumer retailing and services. And as consumers shift their habits from buying “things” to pursuing “experiences,” and shopping online instead of at brick-and-mortar stores (which axes profit margins in a big way), big chunks of the sector are imploding while others are booming. At the same time, a handful of macroeconomic issues might prove to be another disruptor.
“Retail isn’t dying; it’s evolving,” said Marshal Cohen, chief industry analyst for retail for the NPD Group, a research firm. “Just like it has done before. There has always been disruption in the retail sector.”
Where Are You Headed, Mister?
Inside the sector, strong online and catalog sales as well as those in media and household durables have offset the deep declines in department stores, general merchandise stores, footwear, and luxury goods sales. The U.S. Census Bureau reported that department store sales tumbled 3.2% last year while online sales jumped 12%. And in recent weeks, we’ve heard of a number of retailers shutting down stores, or even leaving the market completely. At least one once-dominant retailer has warned in Securities and Exchange Commission filings about its “substantial doubt” about its ability to remain a “going concern.”
That, some industry experts say, mirrors the evolution of retail and the desire to do stuff rather than buy stuff. Among the highest-flying subsectors of the consumer discretionary stocks? Casinos and gaming.
Given all that, it’s not surprising that consumer discretionary stocks are considered cyclical in nature, meaning the companies behind them tend to generate higher sales when economic growth is robust. Why? It’s in the word “discretionary”: These are the stocks that sell things people don’t necessarily need to survive but like to buy when they’re feeling a little flush, or at least less worried about being able to cover bills. Casinos get big boosts when consumers have jobs and feel good about their lives. Media, which includes everything from your cable provider to the movie theaters you go to, also tend to make gains during economic booms.
But some industry analysts think the consumer discretionary sector may be peaking. Up until about early July, the sector had been running in tandem with the S&P 500 (SPX). Since then it has continued to roughly follow the same patterns of the SPX—running up when SPX did and then retreating with it, too—but the gap between the two has widened on a year-over-year basis with the SPX higher by about four percentage points.
Some analysts, like Sam Stovall, chief investment strategist at CFRA, see that as the beginning of the end for this sector’s heady gains. In February, Stovall’s group downgraded the consumer discretionary sector to “market perform” from “overweight” because of macro and sector-specific headwinds they fear could upend the sector.
Stovall notes that although the job outlook still appears sharp, any big upticks in the economy won’t necessarily translate into consumer outlay on more goods and services. He, and others, see the environment of rising interest rates, a possible border tax that many fear will lead to higher prices for consumers, and rising foreign exchange and global trade uncertainties as potential headwinds. That’s not to say things can’t change on a dime, especially in what many think is an economy still in expansion mode.
For example, higher interest rates on their own aren’t likely to tether consumer spending, but could underpin further shifts in the changing habits of consumers. And then there’s the ongoing apparel malaise that doesn’t appear to be at its end just yet.
Merrill Lynch analysts feel much the same as Stovall’s group, according to a recent report. But they also note the upside in that “the sector is home to many disruptors, consumer confidence is near cycle highs, and consumption plays could get a jolt if personal income taxes are cut, which is popularly believed to be part of the next tax reform bill.”
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