The Consumer Goods & Retail Industry is composed of multi-national companies that manufacture and distribute finished goods and services to consumers. Companies in this industry classify as either consumer discretionary or consumer staples. The consumer discretionary sector deals with companies that experience an increase in demand for their goods and services during times of economic growth. On the other hand, in the consumer staples sector, the demand for a company’s goods and services tends to increase during times of economic contraction.
In the past year, the Consumer Discretionary Select Sector SPDR ETF (XLY) outperformed the broader market with a total return of 29.9% in comparison to SPDR S&P 500 ETF’s (SPY) total return of 15.2%. With an improving macroeconomic backdrop in the United States and a strengthening global economy, the consumer discretionary sector should continue outperforming the market while the consumer staples sector should continue underperforming.
Over the last few years, consumers are becoming more concerned with their health and the products that they are consuming. Individuals are shifting away from junk food and sugary drinks to premium, organic and all-natural brands. Companies such as PepsiCo, Inc. (PEP) and General Mills (GIS) are in a position where they need to align their product portfolios with consumer’s interests. On the other hand, companies such as Lululemon Athletica Inc. (LULU) and Planet Fitness (PLNT) have experienced an increase in sales and their stock price as a result of this trend.
Since the 2008 Global Financial Crisis, per capita disposable income has increased approximately 25% to $14,398.40. With the unemployment rate at the lowest level in almost 18 years and U.S. growth continuing to increase, per capita disposable income is only expected to improve. Companies who offer discretionary goods such as makeup, designer clothing, electronic appliances, and cars should experience increased sales.
As a result of recently passed tax reforms in the United States, companies are utilizing repatriated cash to acquire other companies and products. Recently, Michael Kors (KORS) announced the acquisition of Italian designer Gianni Versace SpA for approximately $2.35 billion. By doing so, Michael Kors will be able to improve a product portfolio that already includes the Jimmy Choo brand. We can expect other companies to follow suit as they are looking to offset any risk of a decrease in sales over the next few years.
Consumer Goods & Retail companies generate a substantial portion of their revenues in developing regions. With Emerging Market equity and fixed income markets selling off as a result of political and economic instability, companies operating in this region can experience lower sales growth and can face currency conversion risk when reporting sales.
The yield curve, which is the difference between the 2-year and 10-year treasury yields, has been an accurate indicator for upcoming recessions in the past. As of September 28, the yield curve is currently at 0.24%, which is almost the flattest it has been since the beginning of the Global Financial Crisis. If the yield curve is an accurate predictor of economic slowdowns, we can expect consumers to shift from discretionary goods to staples in the next few years.
In general, the Consumer Goods & Retail Industry is expected to outperform the broader market over the next 1-2 years and to remain neutral in the long term with increasing worries of an economic slowdown. As long as a recession does not occur earlier than expected, the industry tailwinds discussed in this article should outweigh any headwinds. With increasing per capita disposable income, a decreasing unemployment rate, and improving macroeconomic conditions, consumers should be poised to continue shopping at retailers, more specifically, those that offer discretionary goods.
By Dominik Sochon - Director of Consumer Goods & Retail, Baruch Investment Management Group