Outlook good for consumer discretionary

Consumer discretionary companies have been outperforming consumer staples because of two factors.

“The first one is richer valuation, reflecting an anticipation of stronger earnings growth,” says Jean-Baptiste Nadal, managing director and lead portfolio manager at Metropolitan West Capital Management in Newport Beach, Calif.

“Consumer spending is expected to rise further in parallel with continuing growth momentum in the U.S. economy,” he adds, noting that overseas growth could also push discretionary spending. “[For] companies in the U.S., a large portion of their sales comes from [international] markets. It’s clear that those businesses will benefit.”

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But beware, says Nadal. “If the dollar continues to appreciate versus foreign currency, the earnings of those companies with large international exposure will be pressured.”

The second factor causing strong consumer discretionary performance is low interest rates, which let companies offer strong dividends and cash flow, says Nadal. “So going forward, the sector should continue to do well if interest rates stay low or rise only moderately.”

Plus, he says, “Continued low energy and basic material prices should help those companies to maintain or improve their margins.”

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Outlook for 2015

Nadal says there are several issues that could affect consumer spending decisions this year.

“If energy prices rebound strongly, consumers may feel constrained,” he says. “A significant increase in volatility in the U.S. equity markets may lead consumers to err on the side of caution.”

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And, consumers’ income could have an impact, says Nadal. “As the middle class continues to face low income growth, we should not anticipate a dramatic change in consumer spending patterns. But as unemployment moves closer to full employment, we may see some upward movement in hourly wages, which would be good for the sectors.”

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