Investors are showing more confidence in U.S. spending after the worst slump in 12 months for shares of consumer-discretionary companies.
After falling to a one-year relative low on May 7, the Standard & Poor’s 500 GICS Consumer Discretionary Sector Index is starting to rally, outpacing the benchmark S&P 500 Index by 1.4 percentage points since then. This suggests an easing of concerns about the economy that fueled a 6.9 percentage-point decline earlier this year in the large-cap consumer group -- made up of Amazon.com Inc. (AMZN:US), Walt Disney Co. (DIS:US) and 83 other companies.
The shift “presents a buying opportunity if you’re bullish about the U.S. consumer,” said Timothy Ghriskey, chief investment officer at Solaris Asset Management LLC in New York, which helps manage about $1.5 billion in assets. While the world’s largest economy contracted in the three months ended March 31, hiring hasn’t deteriorated, which supports an improvement in retail sales, he added.
U.S. employers increased payrolls by 288,000 workers in April, the biggest rise since January 2012, Labor Department figures show. Monthly gains have averaged 214,250 so far this year, up from 194,250 in 2013.
Similarly, the Russell 2000 Consumer Discretionary Index has outperformed its benchmark by 1.6 percentage points since Feb. 18, after lagging behind by 5.9 percentage points for the previous seven weeks.
Trading has been “very choppy,” particularly for the small-cap consumer group, though a bull case could be emerging, Ghriskey said. Amid this volatility, both indexes may be establishing relative bottoms, which is encouraging for investors who anticipate consumption will bounce back after the first quarter’s weather-induced slowdown, he said.
Another reason for the optimism is the availability of consumer credit, which is a leading indicator of retail-sales growth by about nine months, according to Dan Binder, an analyst at Jefferies & Co. in New York.
The net percentage of financial institutions reporting increased willingness to make installment loans, which include credit cards, was 11.6 percent in the most-recent survey of senior loan officers released May 5 by the Federal Reserve. That’s in line with an average of 13.7 percent in the past four surveys, which is consistent with spending gains of 2 percent to 4 percent through 2014, Binder said.
While such growth isn’t “great,” it’s probably better than the pessimistic outlook reflected by the prices of many small-cap consumer stocks, Binder said. For example, Container Store Group Inc. (TCS:US) and regional appliance and electronics retailer hhgregg Inc. (HGG:US) have fallen 42 percent (TCS:US) and 34 percent (HGG:US) this year. Binder has hold recommendations on both.
Retail sales rose 4 percent in April and 4.1 percent in March from a year earlier, following an average increase of 1.7 percent in the prior two months, according to data from the Commerce Department. May figures are scheduled to be released June 12.
Amid signs a “modest” economic expansion still is intact, Matthew Spitznagle, senior research analyst in Stowe, Vermont, at Eagle Asset Management, likes small-cap stocks that cater to higher-income consumers with “more financial capacity to spend.” His fund currently owns Del Frisco’s Restaurant Group Inc., Steven Madden Ltd. (SHOO:US) and Vitamin Shoppe Inc. (VSI:US) -- all members of the Russell 2000 consumer group -- because of their expansion plans and growth potential.
Shares of Vitamin Shoppe have fallen 19 percent (VSI:US) this year, while shoe company Madden is down 12 percent (SHOO:US). The North Bergen, New Jersey-based nutritional-product retailer could see a boost from easier comparable sales, Spitznagle said. Meanwhile, Steven Madden, in Long Island City, New York, is expanding internationally and has been reinvesting in its business, he said.
Binder recommends Five Below Inc. and Lumber Liquidators Holdings Inc. for small-cap investors. Five Below, a Philadelphia-based specialty retailer targeted at teens and pre-teens, sells “affordable consumables,” and its fiscal 2015 earnings could increase more than 30 percent, he projects.
Lumber Liquidators, based in Toano, Virginia, plans to double the number of its stores while expanding beyond hardwood and laminate flooring to tools and accessories, he said. It has also announced plans to test selling tile, which is a “potentially new and large category.”
Among the large-cap consumer stocks, Ghriskey’s company currently has positions in VF Corp. (VFC:US) -- with the North Face, Nautica and Wrangler brands -- in part for its acquisition potential, as well as in retail farm-store chain Tractor Supply Co. (TSCO:US) because its business model is somewhat immune to Internet competition, he said.
Even so, this year’s selloff could be a harbinger of further weakness for consumer stocks, cautions Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc.
“There are no signs of stabilization” in the relative performance of these large- and small-cap indexes longer-term; in fact, a bigger shift out of these equities could be starting, he said.
On a short-term basis, if the small-caps trade below their Feb. 18 relative low, this will reinforce the bear case, Stellakis said. Meanwhile, the January-May decline in the large-cap group barely retraced any of its five-year 154 percentage point outperformance, which shows there’s more potential downside risk, he said.
Still, the year-to-date declines aren’t unusual, Ghriskey said. In 2012, the S&P 500 consumer index trailed the benchmark by about 4.2 percentage points between May and August, ahead of a 17-month rally. Small-cap consumer stocks have experienced a bumpier post-recession rebound, which included an 8.2 percentage-point decline during four months in mid-2010.
The Fed’s policy-making Open Market Committee has highlighted “several important factors” that support a better backdrop for spending, including gains in real disposable income, housing prices and consumer sentiment.
“Recent indicators pointed to a rebound and suggested that the economy had returned to a trajectory of moderate growth,” according to the minutes of its April 29-30 meeting released May 21.
Similarly, MasterCard Inc. (MA:US) sees signs of improvement, Chief Executive Officer Ajay Banga said at a May 19 conference hosted by JPMorgan Chase & Co. Consumer spending is in “a decent phase,” as the first weeks of May were similar to April, he said.
While it’s still too early to conclude demand has definitely rebounded, bullish investors should make this bet now, Ghriskey said.
“If you wait, you could miss the biggest relative gains in consumer stocks this year.”
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