Consumer Stocks Stall Amid Surprising Earnings

Better-than-expected profits and sales aren't helping consumer discretionary stocks maintain last year's big gains

By Ben Steverman

The American consumer is showing surprising signs of life lately, even if the stock market has given consumer companies little credit for improvement. The Standard & Poor's 500 Consumer Discretionary index is down 4% in 2010, just ahead of the broader S&P 500-stock index, which has declined 5.2% so far this year.

Profits and recent sales results for many consumer stocks are blowing away analyst predictions. So far 29 of 80 stocks in the S&P 500 Consumer Discretionary index have reported fourth-quarter earnings. Unlike consumer staples companies that supply customer needs, the consumer discretionary sector generally supplies customer wants. It consists of a variety of retailers, restaurants, homebuilders, automakers, media operators, and tourism companies. According to Bloomberg data, the sector is posting earnings 348% higher than a year ago and 30% above what analysts had predicted.

"It's been surprising how wide their profit margins have been," says Jeff Kleintop, chief market strategist for LPL Financial. Fearing "the Great Depression," he says, retailers and other consumer-focused businesses slashed costs and inventories. In 2009 consumer stocks "got lean and mean," says Mike O'Rourke, chief market strategist at brokerage BTIG. The prospect of wider profit margins helped drive a rapid advance for consumer stocks, he said.

In 2009, the S&P Consumer Discretionary index advanced 38.8%, rebounding from a 34.7% drop in 2008. This year, O'Rourke says, investors are looking not just for profit growth, but for sales expansion. In order for consumer stocks to keep rising, "the 2010 story is going to have to be a better-than-expected recovery in the economy," he says. Although the signs are very early, January data from some retailers suggest such improvement could be on the way.

upper middle class: buying again

Broadline retailers saw sales rise 2.4% in January, according to Deutsche Bank (DB), and many individual retailers did far better. Nordstrom (JWN), for example, saw same-store sales rise 14% in January, far more than the 5.4% advance Wall Street was predicting. Analysts forecast flat sales at Macy's (M), but the department store reported a 3.4% increase in same-store sales. Kohl's (KSS) saw same-store sales rise 6.5%, more than twice Wall Street's expectations.

While all consumers still feel some economic pinch, wealthy and upper-middle-class consumers are growing more confident, says Lisa Walters, principal at research and consulting firm Retail Eye Partners in New York. Lower-income consumers—many living "paycheck-to-paycheck," Walters says—continue to favor value retailers such as Wal-Mart Stores (WMT) and Target (TGT).

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