By Aaron Kuriloff
With U.S. stocks at new highs, investors are looking to consumers for signs the rally will last.
The stock performance of retail stores and auto makers, restaurants and hotels -- among the so-called consumer-discretionary companies -- marks the next critical test for a market that has been led by safety plays such as utilities and other staples companies.
"The consumer is really carrying the ball here for us," said Jeff Kravetz, regional investment director at the Private Client Reserve at U.S. Bank Wealth Management, which manages about $133 billion. The beginnings of a shift out of the more defensive sectors is "really based on how strong the consumer is," he said.
On several counts, conditions look ideal for U.S. consumers. Mortgage rates are low, the labor market is solid and U.S. stock indexes are at record highs. Yet the pace of job creation has slowed in the past three months, wage increases have been soft since the financial crisis and shares of consumer-discretionary companies are relatively expensive, threatening to limit price gains.
Investors will get a fresh look at the sector this weekas companies including Hasbro Inc., Starbucks Corp. and Chipotle Mexican Grill Inc. are scheduled to report earnings. Consumer discretionary is one of four S&P 500 sectors expected to report year-over-year earnings growth, while corporate earnings for the broader index are expected to decline for a fifth consecutive quarter, according to FactSet.
Economic data also show some promising trends for consumer spending, which accounts for more than two-thirds of economic output in the U.S. The June jobs report showed the strongest month of U.S. hiring since last October, after a disappointing May, and pay has ticked up gradually. Household spending on everything from cars to airfares was up in May and April, according to the Commerce Department, and retail sales climbed in June.
Peter Dixon, who manages the more than $1 billion Fidelity Select Consumer Discretionary Portfolio, with top holdings as of June 30 that included Amazon.com Inc., Home Depot Inc. and Walt Disney Co., said the improving economic picture was creating opportunities within the sector, if not lifting all stocks.
"We're moving in the right direction and that should be favorable for a lot of companies," he said.
Internet and catalog-retail companies are expected to report double-digit earnings growth, along with auto manufacturers and auto-parts and household-durable-goods companies, according to FactSet.
Internet and catalog companies in the S&P 500 have gained 8.6% since the post-Brexit selloff, and online retailer Amazon hit a record high last week. Even if consumer spending falls, Amazon would be among those least affected because consumers are shifting from department stores and malls to online alternatives, said Colin Sebastian, research analyst at Robert W. Baird & Co.
Another promising sign for consumer-discretionary stocks is that investors have begun moving from the relative stability of S&P 500 sectors such as utilities, which is up 20% in 2016, toward areas with better potential for growth, such as the technology sector, which has climbed 9.1% since the post-Brexit low, compared with a 1.8% gain for utilities.
Since the stock market's dip on June 24 and June 27 after the U.K. voted to leave the European Union, the consumer-discretionary sector in the S&P 500 has gained 8.2% and the S&P 500 has climbed 8.1%.
But some investors aren't ready to bet big on consumers.
Consumer-discretionary companies are now trading at roughly 20 times their past 12 months of earnings, above their 10-year average price-to-earnings ratio of 15 and higher than the S&P 500's current P/E of 19.
Average hourly earnings growth is still about a percentage point below its precrisis levels, according to the U.S. Bureau of Labor Statistics. Sales of motor vehicles and auto parts, long buoyed by low interest rates, were up 0.1% in June after sliding in May. Sales at restaurants and bars were down 0.3%.
"People have lost their marbles since the last payroll report," said David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc., which manages about eight billion Canadian dollars (US$6.2 billion). "The view that the consumer is going to write big checks to support the expansion has a lot of hope attached to it, but I don't see where it's going to come from."
Eddie Perkin, chief equity investment officer at Eaton Vance, which manages more than $325 billion in assets, said record-low bond yields have increased demand for consumer-staples shares, which has spilled over into discretionary shares and stretched valuations.
"It's reasonable to think that the consumer is in good shape, but that's been true for a number of years," he said. "The inflection point for the economy has to come from another source."
--Akane Otani contributed to this article.
Write to Aaron Kuriloff at email@example.com