Don’t fall in love with consumer stocks
In investing, as in romance, sometimes you have to move on. If the true object of your affection proves unresponsive to your desires, you naturally turn to the alternatives and focus your resources where you think you might get a different experience, at least.
Maybe too, you resent the old paramour, and look for something — anything — that’s as different from your past love as possible. So what if your new significant other isn’t, well, perfect?
For years, Canadian investors have romanced the oil and gas industry. But now we all know just how fickle the energy market can be and so many have turned to stocks that are as far from energy as possible — namely, to the Canadian consumer.
Stocks in companies that sell non-essential goods and services (clothing, automotive, media and so on) have been real bright spots in an otherwise dreary market this year. The S&P/TSX Capped Consumer Discretionary index, which captures 24 stocks, has been on a roll, rising by almost 12 per cent from mid-January (and 130 per cent since mid-2011).
True love at last? Well, despite or maybe because of recent gains, it’s fair to ask whether investors should really be buying into the Canadian consumer story. Maybe, instead, they should be wary of falling victim to a rebound romance.
One reason for doubt: The runup in consumer discretionary stocks has coincided with a strong climb in consumer staples. Stocks of the latter companies — which sell essential stuff such as food — have risen in line with consumer discretionaries.
The dual run-ups have led priceto-earnings ratios to soar to more than 25x for discretionaries and more than 30x for staples. By comparison, the P/E for the S&P/TSX composite is less than 20x.
In normal markets, you’d expect discretionaries to do better in good economic times, when consumers have mad money; staples should do better in recessions, because folks gotta eat.
That the two are moving in lockstep suggests investors may be piling into consumer stocks simply because there is nowhere else to go. And that imperative doesn’t always lead to good decisions.
On the face of it, however, there is some reason for faith in the consumer.
Many analysts expect economic growth to rebound from its dismal first-quarter performance (GDP was down 0.1 per cent in January), as oil prices recover and the twin benefits of cheap interest rates and a lower Canadian dollar spur business investment.
Consumer sentiment, meanwhile, is high, no doubt in part because the cost of carrying our mountains of debt isn’t rising. On top of that, we’re paying less at the pump thanks to cheap crude, and that means we have more cash in our pockets. And when people have more cash, they tend to spend it.
On the other hand, there is just as much cause, if not more, to be worried about the consumer outlook.
There’s that nagging problem of negative economic growth, for one, and the Bank of Canada recently opined that the impact of lower oil prices on the oilpatch may bleed into other sectors of the economy.
Jobs, meanwhile, have proven frustratingly resistant to mean- ingful growth. Job numbers contracted in February from the previous month and unemployment now stands at 6.8% — which is not terrible, historically.
But the composition of the workforce is also changing. Temp jobs and self employment have grown over the past year at a far faster pace than full-time employment, which is basically flat year over year. Maybe employers know something optimistic consumers don’t.
Retail spending through January was awful. Meanwhile, household debt-to-disposable income reached an all-time high in the fourth quarter of 2014, although net worth is also rising.
If the economy continues to contract, if real job growth doesn’t kick in or if there’s a correction in housing markets, how many Canadians are really going to be inclined to spend more?
Granted, the solid performance of a basket of consumer stocks might not be a sign of irrational exuberance.
The consumer discretionary index, for instance, includes autoparts companies such as Magna International Inc., Martinrea International Inc. and Linamar Corp., which are partly plays on the U.S. economic recovery. It also includes “recession-proof” retailer Dollarama Inc.
Another factor to consider is that there are very few companies in the consumer indexes in Canada (24 in discretionary, 10 in staples), which means any moves can produce outsized results. Poor diversification works both ways, of course, and magnifies upside and downside risk.
Put it all together and investors should probably tread carefully.
Maybe there’s a better consumer story around the corner.
Probably, warmer weather will encourage winter-weary Canadians to spend. Possibly, the economy will work the oil shock out of its system by the second quarter and growth will rebound.
Perhaps it makes some sense for investors to play the consumer field right now.
Just don’t fall in love.
Jobs have proven resistant to meaningful growth