- Fundamentals for the consumer discretionary stocks have improved and the sector has had strong performance relative to the market so far this year.
- Fidelity managers have been looking for opportunities tied to consumer trends, including spending on travel, gaming, and other experiences.
With unemployment down, tax bills dropping, and some signs of wage inflation, there are several tailwinds to help drive consumer spending. Stocks in the consumer discretionary sector have also seen some fairly good times. This sector is composed of industries such as automobile producers and auto components, household durables, hotels and leisure, media, retail, and textiles.
The sector has shown improving fundamentals and relative strength this year, while posting the best performance of any sector other than technology in 2018. What's next? Viewpoints checked in with a number of Fidelity investment professionals for their views on where the sector may be headed, and what trends might drive performance. Among their best ideas: travel and gaming.
Denise Chisholm, Sector Strategist
Strong fundamentals and technicals
Consumer discretionary fundamentals have been incredibly strong. The sector's corporate profit margin, measured by earnings before interest and taxes, has been trending higher since the 1960s. As of March 2018, it was above 11%.
Also, the relative earnings yield for the sector is well above that of the S&P 500. Since 1926, when the sector's relative earnings yield was in the top quartile of its historic range (as it currently is), that has meant consumer discretionary stocks as a group were more likely to outperform the S&P. When it has outperformed in this scenario, it has done so by 4% on average over the subsequent 12 months, according to data from FactSet.
Additionally, there have been almost 1,000 net positive earnings revisions so far this year. Since 1926, when that number was greater than 500, the sector has outperformed the S&P 67% of the time over the following 12 months, compared to 53% of time periods overall.
Lastly, after trading in a sideways range for 2 years, the sector seems to be breaking out and resuming the uptrend seen after 2008 (see S&P 500 consumer discretionary sector chart).
Fidelity Select Consumer Discretionary Portfolio
Consumers are willing to pay for recreation and vacations
I'm bullish on consumer discretionary trends, especially as expectations for the economy have improved following several years of slow growth. Low unemployment and rising wages remain supportive of consumer spending. Also, the tax reform passed in December could add to US GDP (gross domestic product) over the next few years and further help spur consumer spending.
US consumers continue to spend less on household equipment, home furnishings, and automobiles relative to prior years, but are still opening their wallets for recreation and vacations. The percentage of households planning vacations has grown sharply in the past year.
The growing spending on travel could benefit specific firms that offer unique experiences for consumers in segments such as travel, skiing, and gambling.
I believe a number of hotel chains and companies that cater to skiers and gamblers could benefit from the "experiences" trend in 2018 and beyond, as may several social media firms that cater to travel, sports, and leisure.
I am particularly positive on cruise lines, where industry fundamentals have been better than they've been in years. Cruise operators have overcome many challenges related to passenger safety in recent years. In 2017, several major cruise lines began to book trips further out into the future, and also have been carefully managing add-on services—excursions, massages, photo packages, and more—to pull in additional revenue. As of March 31, cruise lines Carnival (CCL) and Royal Caribbean Cruises (RCL) were among my fund's holdings.
Another consumer trend I think looks bullish is housing and home improvement, mainly because millennials may be in a better position to purchase houses. I also like companies with improving profit margins and shareholder dividend rates, as well as reasonable valuations, because I believe these types of stocks should outperform over time, regardless of the backdrop.
Fidelity Leveraged Company Stock Fund
Gaming stocks are still well-positioned
The Fidelity Leveraged Company Stock Fund has been invested in gaming stocks since late 2016, and I think this category is still well-positioned to benefit from global economic growth and positive consumer spending trends.
Demand for casinos tends to be steady throughout the business cycle, which helps gaming companies generate free cash flow from operations. Within the US, I expect a limited number of new casinos to come online. That may benefit existing operators.
Macau, an autonomous coastal peninsula territory of China with many casinos and hotels, may offer comparatively more growth as there's still a lot of untapped demand among potential visitors from mainland China. There is a new bridge to get to Macau that decreases visitors' travel time and could result in increased tourism and higher profits.
Notable gaming stocks held in my fund, as of March 31, included Melco Resorts & Entertainment (MLCO), Las Vegas Sands (LVS), and MGM Resorts International (MGM), all of which have properties in Macau.
Fidelity Growth Strategies Fund
Millenial spending trends
Not all companies that stand to benefit from consumer spending deal directly with consumers. While I tend to build Fidelity® Growth Strategies Fund based on bottom-up, stock-by-stock analysis, I recently positioned it in areas where I see secular growth trends, such as millennials' reliance on technology. I believe this generation is more technologically adept and more likely than any other to trust technology in their everyday lives.
For example, as of the end of February 2018, I saw various long-term opportunities among semiconductor companies that could benefit from millennials' adoption of technology and connectivity, even though some of these companies may have a less certain outlook in the shorter term.
As of March 31, the fund's semiconductor holdings included ON Semiconductor (ON), Analog Devices (ADI), Microchip Technology (MCHP), and Skyworks Solutions (SWKS).
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