Consumer discretionary stocks may lag behind the market after five consecutive years of outperformance, even amid resilient spending by Americans, as investors look to industrial and other companies for gains this year.
While job creation, tame inflation and rising home prices support “solid” retail spending in 2013, consumer cyclical stocks may not keep pace with the market, said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which oversees about $325 billion. That’s because these positive economic trends are largely reflected by the performance of the Standard & Poor’s 500 GICS Consumer Discretionary Sector Index, which has outpaced the broader market by 58 percentage points since 2008, he said. This is the longest such streak since 1990.
Investors have been “paying up” for projected earnings growth in the consumer index, made up of 83 companies including Amazon.com Inc. (AMZN:US) and Walt Disney Co., Paulsen said. Now, with attractive bets elsewhere, “these stocks may just mark time, even though their fundamentals probably will hold up.”
Retail sales rose 0.5 percent in December, the biggest gain in three months, following a 0.4 percent increase in November that was more than previously reported, according to data released yesterday by the Commerce Department. U.S. employers added 155,000 jobs last month, the third consecutive month when nonfarm-payroll growth exceeded economists’ forecasts.
The S&P 500 Industrials Index -- which includes 60 companies such as United Technologies Corp. (UTX:US) and Caterpillar Inc. (CAT:US) -- is one of the “better opportunities” that Paulsen is moving into this year. After underperforming the market by 7.9 percentage points from Feb. 2, 2012, to Sept. 25, 2012, these stocks are “better valued,” boosted by “reaccelerating emerging-world economies” that are important markets, he said.
A gauge of China’s manufacturing activity, at 50.6 (CPMINDX) in December, matched the prior month’s reading, based on the Purchasing Managers’ Index released by the National Bureau of Statistics and China Federation of Logistics and Purchasing. This was the third straight month above 50, which indicates expansion. Meanwhile, the Citigroup Economic Surprise Index for emerging markets, at 1.8 (CESIEM) yesterday, has been positive in the last four readings after averaging minus 7.23 in 2012.
For investors with an optimistic take on global growth, shares of industrial companies could provide “more of a punch,” said Quincy Krosby, market strategist for Newark, New Jersey-based Prudential Financial Inc., which oversees more than $1 trillion. While these stocks have been “beaten down” amid concerns about the European debt crisis spreading beyond the region and slowing growth in China, there’s a “turning point” as these economies appear to be stabilizing, she said.
“Money managers have to go in early, they can’t wait until everything is perfect” to beat the market, Krosby said.
The consumer discretionary index started outperforming the market in 2008, before retail spending began improving and prior to the stock market bottom in March 2009 -- a sign of the disconnect between “Wall Street investing and Main Street activity,” Paulsen said.
These stocks now are “overextended” -- trading at about a 27 percent premium to the industrials-sector index based on the trailing 12-month adjusted price-to-earnings ratio, he said, citing data compiled by Bloomberg. This compares with a 20-year historical average of about 13 percent.
While some companies in the consumer index “continue to demonstrate strong performance,” investors probably will start rotating out of these stocks before any negative earnings results, said Eric Teal, chief investment officer at First Citizens BancShares Inc., which manages $4.5 billion in Raleigh, North Carolina.
The deal between President Barack Obama and Congress to avert tax increases and federal spending cuts due to take effect as the year began also may be a drag on this industry, he said.
“People are beginning to realize that the fiscal cliff is not just a rich man’s problem but is much more broad-based and that this has a potential to impact consumer spending at all different levels of the economy,” Teal said. “In the intermediate term, we will decrease some exposure to consumer discretionary stocks.”
Congress passed a compromise that Obama signed into law Jan. 2 that averted income-tax increases on most Americans and delayed automatic spending cuts until March 1. U.S. paychecks already have shrunk this year after Congress let the payroll tax that funds Social Security benefits revert to 6.2 percent from 4.2 percent.
Even as the consumer discretionary index becomes less attractive, industrial companies still need to demonstrate better earnings growth to entice Teal’s fund, which is “market weight” on this industry, he said.
“We’re straddling the fence right now,” Teal said. “We’re really looking for opportunity to rotate there, but we haven’t seen the characteristics we’d like to see on that side of the trade yet.”
Still, some investors already have moved into these stocks in recent months, as the index has outperformed the S&P 500 by 4.9 percentage points since Sept. 25. If consumer discretionary shares were to lag behind the market, this would signal a more widespread sentiment shift is under way.
Investors probably will pay particular attention to “large-cap names with international exposure,” during earnings season to gauge whether demand has improved, Krosby said. Companies such as Caterpillar -- “the darling of the industrials during the period of strong Chinese growth” -- will attract more investment because they offer a “good barometer” of this industry, she said.
“Sector outperformance is born in the worst of times and dies in the best of times,” Krosby said.
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