November 1, 2005
THE CASE FOR PLAYING DEFENSE IN CONSUMER STOCKS
Investors can't pay too much attention to the consumer. In good times, consumer spending is the fuel that drives bull markets. But the trend has been known to work in reverse as well. The challenge is figuring out which side of the coin will dominate, and for how long. Turning points, as always, are the tricky parts.
For the moment, Joe Sixpack and his counterparts across the nation continue to generate the lion's share of economic activity in the U.S., representing about 70% of GDP as of the third quarter, according to the Bureau of Economic Analysis. Although the consumer will almost certainly remain the economy's primary engine for the foreseeable future, if not indefinitely, recent trends in sentiment measures raise questions for the short term.
Consumer expectations this year have fallen to lows last seen in the recession of the early 1990s, as measured by the widely followed series produced by the University of Michigan via an October 31 research note published by Safian Investment Research. It's interesting to note, that consumer confidence by age groups sharply differ. Citing another data series from the Conference Board, Safian observes that the under-35 crowd is substantially more optimistic about the future compared with the relatively gloomy 35-plus crowd. Nonetheless, all three age-based consumer confidence indexes remain in downtrends.
Is this a sign that Joe's about to end his penchant for spending? Perhaps, but the signs are still mixed from a quantitative perspective. Personal income, Joe's ace in the hole that allows him to keep spending, soared by 1.7% in September, BEA reported. Was that a surprise? Absolutely, with some economists expecting a rise by as little as 0.2%.
But if the sharp advance in personal income was an excuse to go on a spending spree, Joe wasn't biting. Personal spending rose but at a substantially slower rate in September--0.5%. That reverses the 0.5% decline of August, but it pales in comparison to the 1.0% and 1.4% of June and July, respectively.
Joe arguably needs to curtail his spending anyway. Personal savings as a percentage of disposable personal income declined by 0.4% in September, the fourth consecutive month of descent.
Does this all add up to a warning of things to come from an investment perspective? It's starting to look that way to judge by a a performance comparison between the consumer staples and consumer discretionary sectors of the S&P 500 stock market index. This year through October 31, for instance, consumer staples posted a 1% total return. That's slightly better than the S&P 500's slightly loss over the same period (down 0.4% year to date). More importantly, the consumer staples sector (which includes such stocks as Colgate-Palmolive, Campbell Soup, General Mills and other firms whose sales are relatively immune from economic cycles) handily beats the nearly 10% loss for consumer discretionary equities, whose fortunes are more closely tied to sales of items that aren't essential and thus subject to the winds of expansion and recession. Buying a new widescreen TV is fun, but it's a purchase that can be delayed. Don't try that with food.
No wonder that money manager Michael Farr of Farr, Miller & Washington favors the defensive plays among the consumer-oriented companies. "We agree that the consumer is becoming more pinched," he told BusinessWeek today. "The negative savings rate and record levels of credit-card debt worry us. We take a somewhat defensive approach, in that we believe that the consumer in almost any economic condition will continue to buy certain staples, such as toilet paper, soap, and toothpaste." Among his picks: Colgate-Palmolive, the drugstore chain CVS, Staples, Anheuser-Busch, and the tobacco company Altria. "The tobacco stocks are always fairly safe. People will continue to spend when they're addicted. The problem with these addiction stocks is the ongoing liability, but some of that seems to have been removed from the tobacco stocks in this country."
Posted by jp at November 1, 2005 10:20 AM
Does anyone know of a study that correlates the volatility in total return for consumer-oriented companies vs. the economic elasticity of the goods that that company produces? It might shed some light on the point you are trying to make.
Posted by: pww214 at November 1, 2005 12:16 PM