For 2021, the bar for better living is set low. By summer, if I’m not mixing my own hand sanitizer while hoping that the lightning wildfires scare off the murder hornets, it will count as a year-over-year improvement.
Goldman Sachs is plenty upbeat. It says that 70% of people in developed markets will be vaccinated by fall, and that U.S. corporate profits this year will hit new records. The starting point for stock valuations seems high, but even so, it predicts 15% more upside this year for the S&P 500 index (.SPX).
Here’s hoping that’s accurate. If so, tactical investors may want to overweight sectors that tend to do well during economic recoveries. Chief among those is the consumer discretionary sector, which specializes in things people want but don’t quite need. But boosting exposure there can be tricky, because the sector is having an identity crisis.
Years ago, Walmart (WMT) and Costco Wholesale (COST) were moved to the S&P 500’s consumer staples sector, even though both sell a mix of needs and wants. Amazon.com (AMZN) and Home Depot (HD) remain consumer discretionaries—yet during the pandemic, consumers relied on both as never before. Amazon stock gained 76% in 2020, and Home Depot stock, 21%.
When Tesla (TSLA) was added to the S&P 500 in December, it joined the consumer discretionary sector, because cars are categorized as wants. Its shares were up 756% in 2020. A trip to Disney World, meanwhile, might be the epitome of a discretionary purchase, but Walt Disney (DIS) is a media company, and in a sector reshuffling two years ago, those became part of the communications services sector.
Put it all together, and Amazon, Tesla, and Home Depot now make up 54% of the S&P 500’s consumer discretionary sector, according to Credit Suisse stock strategist Jonathan Golub. Add another eight percentage points for Home Depot rival Lowe’s (LOW) and McDonald’s (MCD), whose drive-through lane has functioned like a consumer staple during the lockdown.
That’s not a problem for someone who simply invests in a fund that tracks the overall S&P 500. As the economy reopens, rising consumer activity will be captured in the index somewhere, no matter how it is categorized. But an investor who buys, say, the Consumer Discretionary Select Sector SPDR exchange-traded fund (XLY) for targeted exposure to the recovering consumer gets more of a lockdown play than he or she might expect.
Better to think small. The odd state of the S&P 500’s consumer discretionary sector is owed in part to a handful of companies becoming so large. The S&P 600 and 400 indexes, made up of small and midsize companies respectively, together have one-tenth the weighting in internet retailers as the large-company 500 index. And they have twice as much exposure to restaurants and leisure.
Sector fund choices for small consumer discretionary companies are limited. One is the Invesco S&P SmallCap Consumer Discretionary ETF (PSCD). Another option is to screen for individual names with promising growth. For example, Yeti Holdings (YETI) makes pricey outdoor gear like coolers. I recommended the stock at $22 in a Trader column in Barron’s nearly two years ago. It recently hit $69, which puts it at 34 times projected 2021 earnings. In surveys, consumers say camping trips are a top choice for when travel reopens. Yeti looks likely to grow revenue at a double-digit pace in coming years.
Five Below (FIVE) is a fast-growing retailer of knickknacks, and its reliance on physical stores hasn’t served it well lately. Same-store sales are expected to decline 4.6% during the fiscal year through January 2021. But Wall Street predicts a 16.6% surge the year after that. Shares are priced at 44 times earnings, but before the pandemic, earnings per share were doubling every three years.
If chicken joint El Pollo Loco (LOCO) isn’t immediately familiar, it might be because three-quarters of company-owned locations are in the Los Angeles market. In 2020, the company got lean on costs. Higher margins look likely to stick as the company returns to expanding its store count in 2021 and beyond. Shares fetch 22 times earnings.
Gentex (GNTX) makes car rearview mirrors that dim automatically when they detect headlights from drivers behind. It’s parlaying its dominant market position into other electronics and active safety features. Wall Street expects double-digit earnings growth in the years ahead. The shares go for 22 times earnings.
Chips quietly boomed in 2020. The Philadelphia Semiconductor Index surged more than 50%, beating the S&P 500 and Nasdaq Composite (.IXIC). Now, J.P. Morgan predicts that chip industry sales will rise 8% to 10% in 2021 and fuel earnings growth of 15% to 18%. Leading the increase will be more expansion by the big cloud players, strong growth in base stations for 5G wireless service, and a doubling and then some of 5G handset shipments.
Which chip stocks to choose? Intel (INTC) is cheap at 10 times earnings, but it has never looked more challenged than now, with Apple (AAPL) shifting to its own chip designs for computers. Nvidia’s (NVDA) has excellent exposure to silicon for videogames, cloud computing, and artificial intelligence, but shares fetch more than 40 times earnings.
For a blend of growth and value, look to Broadcom (AVGO). I’ve recommended the shares a few times in Barron’s, starting at $174 more than four years ago. They recently traded at $436, or about 16 times earnings. Broadcom is a roll-up of chip and software companies, with a focus on networking, broadband, storage, and wireless communications. Earnings per share growth is pegged at 8% this fiscal year through October. Shares pay a 3.3% dividend. J.P. Morgan recently called it a top pick for 2021.
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