Consumer-discretionary stocks have had a great year while staples have lagged behind, but it’s smart to be selective in both sectors, according to BlackRock.
Where we were: Consumers are feeling confident and happy to spend lately, although that has not lifted all sector stocks.
Where we’re headed: Discretionary stocks face their own challenges, although BlackRock prefers them to staples.
This year offers a tale of two consumer stock sectors.
On the one side is consumer-discretionary stocks, which have been strong outperformers, while consumer-staples stocks have lagged behind, even after accounting for its summer rally. BlackRock’s Kate Moore thinks that trend is set to continue and prefers discretionary stocks over staples.
Consumer stocks have been under a cloud for much of the year, as trade tensions and tariffs threaten global consumption. But that’s been offset by consumer confidence, which has surpassed pre-financial-crisis levels, Moore notes, thanks to rising incomes.
Even with trade worries, BlackRock expects spending to remain strong, and savings data show that shoppers aren’t dipping into their nest eggs to fuel the surge. These factors should provide an “ample runway” for global consumption, including in emerging markets, as a growing middle class looks to spend their cash.
Yet the rising tide hasn’t lifted all boats, as evidenced by the staples sector’s lackluster performance, and the group has some of the weakest earnings-revisions ratios (a metric tracking analyst upgrades and downgrades) worldwide. “Staples are not necessarily the bastions of steady growth, strong cash flow and high dividend payouts they once were,” Moore writes.
Staples companies face higher input costs, and with brand loyalty dwindling and online alternatives proliferating, it’s hard for big players to pass on those price increases. Moreover, a rising-interest-rate environment has hurt enthusiasm for rich dividend-paying stocks, like the staples. Moore notes that historically, traditionally defensive, higher-yielding stocks have proven less immune to downturns during times of increasing rates. Then there’s the fact that staples have spent less on growth-spurring capital expenditures than their discretionary counterparts.
Of course, discretionary stocks face their own woes, Moore notes, notably from digital disruption. Before this year’s retail revival, many bricks-and-mortar companies were shunned by investors in the face of Amazon.com’s(AMZN) increasing dominance, and new entrants have snapped up share from more-traditional players. There’s a case for being selective in both consumer categories.
So where should investors put their money? Moore says to stick with quality in staples. Earnings revisions may have bottomed for the group, but she cautions that valuations are still only slightly below their five-year average and still trade at a modest premium to the broader market—while the cheapest stocks are cheap for a reason. “We prefer a focus on quality and momentum versus fishing for value in challenged companies,” she writes.
It may be time to expand the definition of what it means to be a defense play, Moore argues. Staples have shown little dispersion across individual names historically, which makes sense given shared characteristics like high dividends, but lately the gap between winners and losers has been growing in the U.S. and other developed markets. “This tells us staples broadly cannot be relied upon as a defensive play, and that investors should be selective,” she writes. “We believe a good defense today is in quality companies demonstrating high profitability, sound balance sheets and strong brands.” Growth potential has to be able to outpace inflation, she argues, leading her to favor U.S. tech stocks.
On the discretionary side, she writes that recent data back up the idea that traditional retail is far from dead, as same-store sales growth has climbed in major developed economies, and sales per square foot in U.S. stores is near record highs. “This points to opportunities in more traditional retail companies that have been beaten down as markets underappreciated the coming of age (and spending) among millennials and the overall health of the U.S. consumer,” Moore writes.
Make the Connection
Speaking of tech, it could keep winning.
Staples are likely to get little relief from interest rate pressure.
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