With Halloween barely in the rearview mirror, retailers wasted little time in stocking winter holiday merchandise in the aisles. Wishful thinking? Recent personal spending data missed Street consensus estimates slightly, but some say overall trends still point to healthy holiday spending. For investors, that could translate into fresh support for consumer discretionary stocks, some analysts say.
Deeper than the Headlines
September personal spending rose just 0.1%, versus consensus estimates for a 0.2% increase, according to government data. What’s more, Q3 gross domestic product (GDP) was running at a 1.5% annualized rate, according to preliminary data subject to revision. That was well below the 3.9% pace registered in Q2. Combined, these reports and more could be enough to raise some jitters for the health of holiday spending.
Not so fast. Digging deeper, a large part of the GDP slowdown was due to a downturn in private inventory accumulation, while the consumer outlook remains strong, suggest Standard & Poor's economists.
"Steady improvement in the labor market has helped give consumers the confidence to spend. For 2015 as a whole, expenditures on personal consumption are on track to grow by 3.1% year over year, which would be the strongest pace of this recovery," says Beth Ann Bovino, U.S. chief economist at Standard & Poor's.
Investors will be watching Friday's release of the October employment report closely to help confirm or refute the positive labor market outlook. Street consensus calls for a 180,000 increase in non-farm payrolls, better than a month ago but off the 200K-plus that would cheer Wall Street’s bulls.
"Overall, the trend in the U.S. labor market is still in a good spot,” adds JJ Kinahan, chief market strategist at TD Ameritrade. “And select earnings reports could help traders figure out if conditions are stronger or weaker than the broader data is letting on. Macy's [M] earnings, for example, due out November 11, could be a helpful barometer of consumer spending heading into the holidays.” Currently, the Thomson Reuters consensus estimate calls for a 20% year-over-year drop in M’s Q3 earnings compared to the year-ago period. But many analysts are expecting improved full-year earnings per share (EPS) for the department store compared to last year.
Sector Focus: Consumer Discretionary
Standard & Poor's economics team argues that consumer spending is projected to increase 3.3% in 2016. For stock investors, this could heighten attention on consumer discretionary equities. S&P Capital IQ currently shows an “overweight” for consumer discretionary stocks (it has only three overweights out of the 10 S&P 500 sectors; the other two are health care and telecom).
Consumer discretionary stocks can potentially benefit from a low unemployment rate and should face only minor impact from upcoming expected Federal Reserve interest rate increases, says Sam Stovall, U.S. equity strategist for S&P Capital IQ.
"On a very broad, macro basis, if we think the U.S. dollar could strengthen as the Fed finally follows through with their threat to raise interest rates, we could see the consumer discretionary sector be less affected. [That’s because] a smaller percentage of sales come from overseas as compared with the S&P 500 overall," Stovall says.
Consumer discretionary is the only S&P 500 sector projected by S&P Capital IQ consensus to generate double-digit EPS growth in the second half of 2015. In Q3 and Q4 2015, earnings estimates for S&P 500 specialty retail constituents peg 11% growth, with a forecasted 14% rate of growth for all of 2016. The “specialty” sub-sector includes Home Depot (HD) and TJX Companies (TJX), for example.
Internet retail companies—a category including Amazon.com (AMZN) and Netflix (NFLX)—are expected to log an even stronger performance, according to S&P Capital IQ analysts. The industry is expected to generate 43% and 54% year-over-year growth in Q3 and Q4, respectively, with 50% growth for all of 2016 over the year-earlier comparable, according to S&P Capital IQ.
And here come the holidays. Spending could provide an added lift to the consumer discretionary sector. Despite the best-laid plans, personal budgets often fall to the wayside during the holiday season. "You see it every year in surveys; folks always spend more money at the holiday than they expected to," notes Kinahan.
Just because the holiday shopping season is right around the corner doesn't mean you should go out and buy all retailers, Kinahan warns. "This will be a story on a case-by-case basis.”
Global Worries Dissipate?
The economic news may have turned a corner elsewhere, too: namely, China. There are signs of recovery in the equity market there and in the manufacturing sector. "Chinese data of late has performed better than expected. We are seeing the Chinese consumer perform well, which helped boost Apple [AAPL] and Nike's [NKE] earnings above Street expectations," notes Kinahan.
Does that apply to more stocks? Research required. TD Ameritrade clients can utilize the company profile function (figure 1) to identify trends in revenue and also pinpoint the source of the income. "If you believe the Chinese consumer is doing well, you may want exposure to China,” says Kinahan. “If you believe China’s economy is slowing down again, you may want to look for domestic exposure.”