Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: There has been a nice run up in the retail-oriented Consumer Discretionary industries over the past quarter. Why have investors been so bullish on retail?
Stovall: The Consumer Discretionary stocks have done very well in the past 13 weeks, gaining 7 percent through Nov. 11 as compared with 4.7 percent for the S&P 500. Also, 11 of the 14 retailers covered within the S&P 1500 rose by double-digits in the past 13 weeks. What really was the catalyst was that Wall Street basically came under the assumption that there will not be a double-dip recession here in the U.S., or if there is one, it will not be generated by a weakness here in the U.S.; it'll probably be the result of some exogenous event such as worsening problems in Europe or possibly in China. But I think investors are saying as, is S&P Economics, that the risk of recession has been reduced. We lowered our expectations of recession from 40 percent to 35 percent a couple of weeks ago. As a result, we ended up with a nice return for Consumer Discretionary stocks in general and retailers in particular, as well as some cyclical sectors doing very well as compared with the overall market since the Oct. 3 low now that investors are less worried about a hard landing in China, or a double-dip recession here in the U.S., and the accompanying erosion of corporate earnings projections. The wild card remains to be Europe, but I think investors believe with the changes taking place in Greece and in Italy, with technocrats replacing politicians, there is an increased likelihood that some sort of ring fencing will take place.
EQ: This is a big week for retail stocks as many of the major companies in this space are supposed to announce earnings. What should investors listen or look out for to determine whether these stocks are overbought or are on track?
Stovall: When you have a sector or sub industry that has risen by 12 percent to 17 percent in the past 13 weeks, chances are that for the near term they are overbought. But once you see some sort of digestion of those recent gains, there could be continued momentum if the earnings come in in-line or slightly better than expectations, and we find that the improved earnings are not simply the result of cost cutting and share repurchase programs, but indeed we start to see an improvement in revenue growth.
Let's face it, consumers have been very concerned, but a lot of the consumer sentiment data have been picking up, implying that consumers are feeling a little bit better about their overall economic situations, where the recession is not likely to repeat itself and that maybe the unemployment picture will be improving rather than remaining lackluster at around 9 percent. So, I would listen for company comments on whether we can actually see a continued growth in earnings in 2012. S&P Capital IQ projects that the S&P Consumer Discretionary sector will see a 12.5-percent increase in earnings in 2012, versus an 8.7-percent increase on the overall S&P 500. If we see retailers in particular, or the Consumer Discretionary sector in general, continuing to post higher than market earnings, growth rates, or that the guidance indicates as such, then that would support the reason why investors would favor some of the retailers.
EQ: Looking at the S&P 1500 Retail returns over the past 13 weeks, Discretionary industries seem pretty much in line with each other. In Consumer Staples, HyperMarkets and SuperCenters seemed to outperform the other three industries by far. Are there any reasons that you've noticed for this drastic difference?
Stovall: I think a little further clarification is needed as to why retailers would be in Consumer Staples rather than all of them being in Consumer Discretionary. The majority of retail is found in Consumer Discretionary, such as your traditional ones like Apparel Retail, Department Stores, General Merchandise, and Specialty Stores. In Consumer Staples, you have Food Distributors, Drug Retail, Food Retail, and the Hypermarkets and Supercenters, which are basically Wal-Mart (WMT), Costco (COST), etc.
The reason why Wal-Mart is in Consumer Staples and not in Consumer Discretionary is because a majority of its revenues comes from food sales, rather than from your traditional retail sales. The price performance of the Drug Retail, Food Retail, and Food Distributors were below that of the overall market because they tend to carry more defensive qualities than the other retailers. The Hypermarkets and Supercenters are up 12 percent in the prior 13 weeks versus the near-5 percent for the S&P 500 because of the dominance of Wal-Mart. In addition, there’s a boost from consumer expectations that we could see a pickup in consumer and retail sales at Wal-Mart, benefiting from a reduction in gasoline prices as well as an improvement in consumer sentiment.
EQ: We're in holiday season now. Is it too late for investors to get in on the typical boost from the year-end shopping season?
Stovall: We still believe that there are some opportunities out there. Certainly, the growth expected is likely to be less in 2011 than in 2010. It is estimated that we should see about a 3-percent increase in retail sales in 2011 as compared with a 5-percent increase in 2010. Therefore, there's still upside potential. In particular, some of the companies that we favor within this category include 10 companies followed by S&P Capital IQ Equity Analysts that carry either Strong Buy or Buy recommendations.
Stocks Rated Strong Buy
- Coach, Inc. (COH)
- Tiffany $ Co. (TIF)
Stocks Rated Buy
- Bed Bath & Beyond, Inc. (BBBY)
- Best Buy Co. Inc. (BBY)
- Dollar General Corp. (DG)
- Guess? Inc. (GES)
- Kohl's Corp. (KSS)
- Nordstrom, Inc. (JWN)
- Staples, Inc. (SPLS)
- Target Corp. (TGT)
In conclusion, it appears as if now that we're heading into the optimal retail season, we could see retailers do relatively well, but that would also be consistent with our Overweight recommendation on the S&P Consumer Discretionary sector. It would also be consistent with history, which indicates but does not guarantee, that the strongest six months of the year tend to favor the cyclical sectors. Since 1945, the strongest six months, being from November through April of each year, has seen the market gain an average of 6.8 percent as compared with only 1.2 percent from May through October.
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