Strong Consumers May Not Lift All Consumer Stocks


The upbeat consumer sentiment we've seen throughout 2017 finally translated into solid consumer spending in April. U.S. retail sales rose a seasonally adjusted 0.4%, reported the Commerce Department, marking the strongest growth in three months.

The solid report suggests sales recovered from an unusually weak start of 2017, partly due to tax-refund delays. But it also shows a widening chasm within retail. Online retailers continue to gain market share, a development acutely felt by apparel and department stores. Macy's ($23; M), Nordstrom ($41; JWN), and TJX ($75; TJX) posted lackluster April-quarter results and guidance in the past week. Yet the Commerce Department indicated solid growth at building-materials stores, supported by Home Depot's ($156; HD) strong quarterly report and raised outlook.

As discussed in the last issue, the consumer-discretionary sector is one of the few spaces in the stock market that looks reasonably valued versus its historical norms. Still, as interest rates inch higher, investors should approach consumer stocks with care.

Over the past 25 years, the consumer goods and consumer services sectors of the Dow Jones U.S. Index have consistently lagged the broad index during periods of rising interest rates, as shown below. Consumer companies often have limited pricing power to recover rising interest expenses and wage costs, which often come late in economic expansions. And there's no shortage of other warning signs.

The White House's proposed travel ban had a chilling effect on the U.S. tourism industry, hurting hotels, restaurants, and retailers in major cities. An estimated 4.3 million fewer people are projected to visit the U.S. in 2017, reducing tourism revenue by $7.4 billion.

Consumers also may be starting to stretch their finances too thin. U.S. credit-card loans are outpacing household income, and several credit-card companies were caught off guard by unusually high charge-offs last quarter.

We recommend investors approach the sector selectively. Our retailers — Foot Locker ($71; FL) and Lowe's ($84; LOW) — have limited exposure to competition from ($945; AMZN). We also like stocks leveraged to the housing industry, such as D.R. Horton ($33; DHI) and Mohawk Industries ($229; MHK). Finally, Carnival ($60; CCL) and its cruise lines appear insulated from any fallout from the proposed travel ban.

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