Michael Cembalest 9/7/21: J.P. Morgan, Chairman of Market & Investment Strategy:
...look at the big picture: rising wages, government transfers and pandemic issues have boosted pent-up consumer spending, and there’s unprecedented pent-up demand when looking at the gap between low inventory growth and high sales growth. Both of these coiled springs will eventually spring back. So will housing, which is now constrained by soaring prices and the tightest supply conditions since 1990 (2-3 months). There’s consumer resistance to higher prices for durables, cars and homes, but ammunition for healthy US consumer spending is firmly in place particularly given improved household balance sheets. As drags from supply constraints and the Delta variant eventually fade, US and global growth should be supported by reopening dynamics, inventory restocking and a lot more capital spending.
The chart below highlights how massive the consumption capacity currently is with excess savings well over $2.5trillion to be drawn down over time. The consumer is NOT tapped out folks.
I talk to Advisors and consumers every week. What do I hear a lot these days? “The market has to go down, it can’t keep going up like this forever…I’m raising some cash to take advantage of the pullback when it comes…”. All of these comments are thoughtful and prudent and a correction can come at any time. However, let me highlight the underlying facts: there has already been a pretty decent correction, the indexes are the only thing that doesn’t reflect this reality. Maybe the actual correction needs to be from the index level but I assure you there’s already a wonderful sale happening under the surface. Here’s a few charts that are important.
“The Market”. Bespoke’s chart of the S&P 1500 by sector which shows the average stocks distance from the 52-week highs. The average Consumer Discretionary stock has already experienced a -19% drawdown offering some fantastic buying opportunities as we head into the holiday shopping period. The average stock in the S&P 1500 is -15.9% from recent highs. I know people love to buy high because it makes them feel good but I much prefer to buy high quality companies AFTER they have experienced a decent pullback. You’re getting that opportunity now.
If you do not have sufficient exposure to the leading Consumer stocks (most do not given consumption is 70% of GDP), now is a pretty good time to begin adding the allocation. If you have an allocation and it’s not sufficiently large given the thematic is $44 trillion annually in scope, now is a great time to build the right sized allocation.
Source: Bespoke, as of August 20, 2021.
The Brands Index Breadth Confirms the S&P 1500 Data Above.
As many of you know, our investable universe is the 200 highly admired brands contained in our Index, the Alpha Brands Consumer Spending Index. We update this 200 index each December. It’s our time to analyze consumer trends and add/delete brands that are not resonating well with consumers.
As of September 3, the average stock in the S&P 500 is 8.9% below the 52-week high yet the Index itself, market cap weighted, it’s at all-time highs. Mr. & Mrs. investor, the correction is well under way already. In the Brands Index, the average drawdown from the recent 52-week highs in the Communications Services sector is -20%, -16.5% in the Consumer Discretionary sector, and -14% in the Consumer Staples sector. I feel confident in saying, the correction in the consumer stocks is absolutely under way and the pullback offers savvy investors some great buying opportunities.
We have been adding to Disney, Amazon, TJ Maxx, Visa, RH(Restoration Hardware), Lululemon, Home Depot and Adidas lately.
By the way, these pullbacks jive with the mid-cycle transition thesis we have talked about for 6 months. As an economy transitions out of the early cycle after a recession, some wicked sector rotation begins to occur as the economy matures & begins to heal. In our opinion, much of that sector rotation is behind us.
Why Do Investors Need a Dedicated Allocation to the Consumer Discretionary sector?
If I’m showing you there’s been a solid correction in consumer stocks and this correction offers opportunity, then I should also show you a wider lens view of how much value the Consumer Discretionary sector can add to a portfolio. To get the longest track record to illustrate my point, I’ll use the grandfather of all U.S. Consumer Discretionary active funds, Fidelity Select Retail, FSRPX. Surely one fund manager should never cite a “competing fund” in its own marketing piece right? That’s not how I roll gentle readers, I have deep respect for the team that manages FSRPX. This is a wonderful fund so long as you understand it is heavily concentrated and therefore prone to large drawdowns on occasion and is less diversified across the consumption theme than we prefer to be. Reality: it’s the allocation to the consumer that’s most important. The investment you choose largely should be determined by the risk tolerance you have. Not to mention, it’s likely the most defendable portfolio decision anyone can make. Why? Literally no client or prospect would dispute the logic that a portfolio needs an allocation tied to the primary driver of the economy in which we invest.
Consumer Discretionary has the best calendar “beat rate” versus the S&P 500
Batting average is very important in sports and in investing. When one analyzes each sector on a calendar basis for outperformance versus the S&P 500, the Consumer Discretionary sector indices have outperformed more often than any other sector at 68% of the time on a calendar basis. The FSRPX fund has outperformed 60% of the time but has added about 326bps of annual outperformance versus the S&P 500 since its inception over 35 years ago in 1985. Let’s put that kind of outperformance into a context people understand better: dollars invested.
A $100,000 investment 35 years ago in the S&P 500 Index from 12/16/1985 to 8/31/2021 would have netted the investor a cool $5 million (dividends & income were not re-invested). The same $100,000 invested in FSRPX would have turned that amount to $13.24 million or over $8 million more than the index fund.
In your retirement could you use that extra $8 million? I think I could. Obviously, this is a hypothetical illustration but it should serve as another proof-point that having dedication to the top Consumer Discretionary brands is likely a very good idea.
The Consistency of Consumer Discretionary Stocks is Clear
The next chart shows the rolling 5 year returns of FSRPX versus the S&P 500. What you can see clearly is this sector allocation tends to win (above the red zero line) much more often than it loses when compared to the S&P 500.
In fact, the periods of consumer stock underperformance tended to be in two unique markets: the tech/Internet boom where investors had no interest in anything other than tech/Internet stocks and during the Financial Crisis when consumers were leveraged to the moon.
Consumers today are as healthy as they have been in 4 decades.