Fund managers look for value in high-priced consumer
sector
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[February 21, 2020] By
David Randall
NEW YORK (Reuters) - Expectations that
spending on items ranging from hotels to clothing will continue to rise
have helped make consumer discretionary stocks the most expensive sector
in the S&P 500.
Now fund managers are looking for ways to profit without getting burned,
if a pullback comes on the back of worries about the coronavirus and
other factors.
The consumer discretionary sector now trades at a forward price to
earnings ratio of 24.2, well ahead of the 23.7 forward valuation of the
technology sector, according to Refinitiv data.
Higher prices for consumer discretionary stocks come at a time when the
broad S&P 500 trades at a forward P/E of 18.9, its most expensive
valuation since 2002, according to Bank of America Global Research.
High expectations will be tested in the coming week as companies ranging
from Macy's Inc <M.N> to Marriott International Inc <MAR.O> to Caesar's
Entertainment Corp <CZR.O> report fourth quarter earnings, giving
investors a broad look at where consumers are choosing to spend their
money and if there are any signs of a slowdown due to the coronavirus,
now known as COVID-19.
Sellers on Amazon.com Inc <AMZN.O>, which constitutes about 26% of the
sector, are already bracing for product shortages due to the spread of
the virus among Chinese workers.
At the same time, consumer companies are among the most likely to be
affected by rising U.S. wages. Goldman Sachs predicts wages will grow at
a rate of 3.5% this year, putting additional margin pressure on
companies that employ lower-wage workers. Average hourly earnings rose
3.1% in January compared with January 2019, according to the Bureau of
Labor Statistics.
"We are now a consumer-focused economy and anything that affects the
consumer will spread out to touch other sectors as well," said Moustapha
Mounah, a research associate at James Investment Research. "We are
looking for companies that can grow their market share without
sacrificing their margins due to wage pressures."
As a result, Mounah is focusing on sectors such as homebuilders and
discount retailers, both of which should benefit from low interest rates
and the ability to pass on higher prices to their customers. At the same
time, he is shying away from restaurants and department stores that have
high fixed-costs and slim margins.
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Traders work on the floor of the New York Stock Exchange (NYSE) in
New York, U.S., February 19, 2020. REUTERS/Brendan McDermid
Overall, sales at clothing stores fell 3.1% in January, the biggest drop since
March 2009, according to the Commerce Department, while overall core retail
sales were unchanged.
Steve Chiavarone, a portfolio manager at Federated Hermes, said he is looking at
discount retailers that have a strong perception of value as part of their brand
identities, which will allow them to maintain high revenues even if the broad
economy starts to dip.
"You are paying for the perceived safety and continued strength of the U.S.
consumer," he said. By focusing on companies that are taking market share,
investors can avoid the risk of an earnings or revenue disappointment, he said.
Overall, consumer discretionary companies are expected to increase their
earnings by an average of 7.2% in 2020, a growth rate trailing projected gains
in energy, healthcare, and technology stocks, according to Refinitiv data. For
the year to date, the sector is up 6.2%, compared with a 3.8% gain in the broad
S&P 500.
Bill Stone, chief investment officer at Avalon Advisors, said the high valuation
of the consumer discretionary sector was a result of Amazon's outsized weight,
with the company's 73 forward multiple bringing up the valuation of the sector
overall. As a result, he is focusing more on companies in the sector like Macy's
and cruise line operator Carnival Corp <CCL.N> that trade at multiples of nine
or lower.
"It's surprising to me that growth stocks have outperformed value by so much,"
he said. "At some point once the coronavirus outbreak passes we should get an
acceleration in the economy and that should finally be the impetus for value
stocks to catch up."
(Reporting by David Randall; Editing by Alden Bentley and Tom Brown)
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