By Amey Stone For almost three years, consumers have done their part in holding up the economy. But in recent weeks, their shoulders have started to sag. As oil prices have spiked, war fears have escalated, and the jobs picture has become more tenuous, consumer confidence, along with personal spending, has dipped (see BW Online, 3/14/03, "One More Cut, Please, Mr. Greenspan").
And as consumer confidence has slumped, so have the prices of stocks in the consumer discretionary sector. Through Mar. 12, the sector was down 10.3%, vs. a 9% drop for the S&P 500. Many retailers have been hurt worse: Saks (SKS) has plunged from $12 to $7.50 in 2003, BJ's Wholesale Club (BJ) from $19 to $9, and Office Depot (ODP) from $15 to $11. "Obviously people are very concerned about the overall health of the consumer," says Charles Watson, consumer and retail specialist at J.P. Morgan.
PAST IRAQ. Retail sales, reported on Mar. 13, add to the warning signs -- even though the disappointing news was ignored by the roaring bull market that day. The February drop of 1.6% -- not surprising in itself given harsh winter storms in the Northeast that month -- was far worse than the 0.4% dip expected. The buoyant Mar. 13 market also shrugged off a worrisome labor-market report that showed new claims for unemployment benefits at 420,000 (anything above 400,000 is considered a sign of declining employment).
All economic evidence to the contrary, however, a compelling case can still be made that consumer stocks could be among the strongest performers in a postwar rally. Just look again at the sharp snapback on Mar. 13, which lifted leading names in the sector even further than the Dow Jones industrial average's 269-point (3.57%) rise. Department-store chain Kohl's (KSS) rose $3.64, or more than 7%, to $54.70. Clayton Homes (CMH) gained 65 cents, to $10.98 -- a better than 6% climb. Starbucks (SBUX) rose $1.56, to $24.06, for a one-day gain of nearly 7%.
Such buoyancy may be an early sign that investors are already looking past the conflict with Iraq, says Watson, although he, and other analysts, are wary about reading too much into one day's action. Nonetheless, he says, "If you're optimistic about the economy eventually getting going -- and the current bet is that we'll have a slow, grinding recovery -- there are some consumer and retail stocks that would be great to put away now for the long term, even if you have to withstand some short-term pain."
RECORD-HIGH SAVINGS. Prudential Securities strategist Edward Yardeni dared advance this view more forthrightly in a Mar. 12 report published as the steep two-month slide in stock prices was still under way. He believes that post-Gulf War II, consumer and business confidence will return, and the economy, earnings, and stock prices will rebound smartly. He points to a record $2.8 trillion in savings deposits (up $100 million in the past 13 weeks alone) as potential fuel for consumer spending and a market rally, and he says the ratio of savings relative to the stock market's capitalization is the highest it has been since the mid-1980s.
Likely winners in this rosy scenario? Yardeni highlights retailers, hotels, and casinos. Six months after the start of the 1991 Gulf War, consumer discretionary stocks were up 33% (vs. 21% for the S&P 500) with casinos and gaming stocks up 120%, home improvement retailers up 79%, and leisure products up 51%, according to Yardeni's data.
Standard & Poor's shares Yardeni's optimism for the sector. The research firm's investment policy committee recommends that investors overweight the consumer discretionary sector, which already accounts for 14% of the S&P 500 (energy and materials are the only other S&P subsectors recommended). S&P five-STARS (or buy) consumer discretionary stocks include Applebee's (APPB), AutoZone (AZO), PF Chang's China Bistro (PFCB), and SCP Pool (POOL), among others. Wal-Mart Stores (WMT) gets the even rarer distinction of making it into S&P's top-10 stock portfolio.
SNAPBACK. J.P. Morgan equity analysts recommend Home Depot (HD), which has seen its stock plummet from $50 to $23 in the past year, as well as Lowe's (LOW), which has held up better in the past 12 months but isn't quite as cheap. PepsiCo (PEP), which has been hurt by concerns about its Frito-Lay and Tropicana lines, is a favorite of the firm's beverage analyst at current prices. (PepsiCo is labeled a consumer staple stock by S&P.) Nike (NKE), which has actually rallied this year, is another of the firm's favorite consumer-spending plays.
To jump into the consumer sector at a point when economic indicators are still weakening isn't for the faint of heart. "If the consumer rolls over, that would be absolutely brutal for the economy and a lot of these stocks," warns Watson. But long-term investors encouraged by the snapback in the sector and looking for stocks that could rebound along with the economy post-Iraq might want to consider a bet that the shoulders of the U.S. consumer are burly -- and will only grow stronger from here. Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column