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Few areas of the stock market are as sensitive to the ups and downs of the economy as consumer discretionary stocks, which is why nimble investors love them.
Consumer spending represents about 70 per cent of economic activity in many developed countries, so stocks that rely upon confident shoppers tend to take sharper dives than the broader market when times are bad and rally harder when times are good.
These ups and downs aren't for everyone. But a well-timed investment in a fund that tracks retail and other consumer-related stocks can be an ideal way to ride the wave of an economic rebound.
"A lot of people with a diversified portfolio already have a lot of exposure to retail and consumer sectors," said Jeff Tjornehoj, head of Lipper Americas Research.
"But for those who are willing to step ahead of the crowd, an economic recovery can bring a strong acceleration on the retail and consumer side."
To be sure, U.S. economic news has turned dark in recent months, with many observers warning that the risks of another recession are on the rise: Unemployment remains stubbornly high, economic activity has turned weak and consumer spending has been declining.
It is no wonder, then, that U.S. consumer discretionary stocks have underperformed S&P 500 since early July, when markets turned particularly turbulent. Some individual names, such as Tiffany & Co. and Gap Inc. have fallen to bear-market lows.
However, recent declines could be a good setup for an eventual recovery.
When the stock market began to recover in early 2009 after the devastating bear market of the previous 18 months, U.S. consumer discretionary stocks led the way. They surged 160 per cent by July 2011, outpacing the S&P 500 by 60 percentage points and defensive stocks by even more.
A recent report from Standard & Poor's noted that the Canadian retail and consumer product companies face the threat of heavy competition from U.S. retailers such as Target Corp. and Lowe's Cos. Inc. as they expand into Canada.
Diversification gets you around this threat. The best approach: Take a global perspective to gain access to the most dynamic companies in the sector, spreading out some of the risks. A number of funds provide the necessary diversification.
Investors Group offers the Global Consumer Companies fund, which invests in a mix of consumer discretionary stocks and steadier consumer staples (split roughly 60/40 in favour of discretionary names right now, among a total of 58 holdings).
"The sector is so broad that there are always opportunities for stock picking in any kind of economic environment," said Peter O'Reilly, head of global equities for Investors Group, noting that a number of companies have been thriving in an uncertain environment.
"I think people are getting a little over-pessimistic at the moment because they have this horror show that was 2008 in their rear-view mirror."
He points to a handful of companies that he finds particularly attractive right now.
Coach Inc. has found a good niche, making handbags that are considered accessible luxury items, with strong potential to expand into China. The shares have fallen recently, but the one-year return is still an impressive 40 per cent.
He sees Christian Dior SA as a cheap way to gain exposure to champagne and cosmetics giant LVMH, which is its main holding. The stock has risen 23 per cent over the past year.
TJX Cos. Inc. , which operates the off-price retailer Winners, has been thriving in good times and bad. Though the share price has fallen a little recently, it is up 27 per cent over the past year.
Yum Brands Inc. has expanded very successfully into emerging markets, especially China, with its KFC and Pizza Hut restaurant brands, and is showing no signs of slowing down.
And Mr. O'Reilly also likes high-end kitchen equipment retailer Williams-Sonoma Inc. , which also owns Pottery Barn.
"It's a high-end name," he said. "It has become one of North America's largest Internet retailers, allowing them to become a lot more efficient in the way they run their business."
Investors can also opt for a number of exchange traded funds – or baskets of stocks that trade on stock exchanges throughout the day – that track retail and other consumer-related stocks, each with a slightly different approach.
The iShares S&P Global Consumer Discretionary sector index fun d follows an expansive index of hundreds of international consumer discretionary companies, including Toyota Motor Corp., McDonald's Corp., Amazon.com Inc., Home Depot Inc. and Sony Corp. The index even includes Canadian Tire Corp. and Tim Hortons Inc.
The SPDR S&P Retail ETF limits itself to U.S.-based retailers and weights stocks equally – boosting the significance of smaller-cap names. Holdings include Netflix Inc., Best Buy Inc., Wal-Mart Stores Inc., Amazon.com and Costco Wholesale Corp.
David Berman