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Amazon's share price has fallen by more 31 per cent since the start of the year.Mike Segar/Reuters

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Few sectors have been beaten up more than consumer discretionary stocks amid concerns about high inflation and a potential recession, leaving money managers wondering what comes next.

“It’s been one of the worst performing among all indexes,” says Jeff Ryall, assistant vice president and associate portfolio manager at Cardinal Capital Management Inc. in Winnipeg.

Further to his point, the S&P 500 Consumer Discretionary index is down about 26 per cent so far this year – the worst of any sector of the S&P 500. Even the S&P 500 Information Technology index is down about 19 per cent.

While equity markets as a whole have been affected negatively by concerns over the highest inflation in three decades, caused by lingering pandemic supply chain issues and the war in Ukraine, consumer discretionary companies have been hardest hit. They’re also considered among the first to see their revenue fall as consumer confidence declines, says Diana Orlic, portfolio manager and wealth advisor with Orlic Harding Cooke Wealth Management Group at Richardson Wealth Ltd. in Burlington, Ont.

That includes previous highfliers like Tesla Inc. TSLA-Q and Canada Goose Holdings Inc. GOOS-T, which are down about 28 and 43 per cent, respectively, this year. Retailers selling a wide variety of products have also seen their fortunes turn quickly.

“Costco Wholesale Corp., The Home Depot Inc. and Target Corp. are other examples with many investors gravitating to them, thinking people are just going to keep renovating only a few months ago,” Ms. Orlic says.

Today, these companies’ outlooks have dimmed with inflation expected to “take a bite out” of household budgets, she adds.

Money managers, in turn, have pared back allocations to the sector. That includes Cardinal Capital, which is underweight the sector.

Still, Mr. Ryall notes the portfolio does hold some companies “that are very liquid, have high quality balance sheets and earnings visibility, pay a dividend and are low beta – in other words, less risky stocks.”

Among them is Sony Group Corp. SONY-N. While its price is down about 27 per cent this year, Mr. Ryall says the electronics company has transformed itself over the past decade, focusing more on high-margin businesses such as music, gaming and imaging.

Gaming and music are now largely streaming businesses and typically “recession-proof,” he says, while imaging involves manufacturing sensors and cameras used in smartphones and automobiles.

“These businesses are increasingly boosting Sony’s revenue.”

Other discretionary companies that may hold up well are those with pricing power able to pass on higher costs to customers, Ms. Orlic says.

“If they can’t pass it onto the consumer, then you are going to see some compression on earnings,” she says.

‘Blurred’ line between consumer discretionary and staples

Many discretionary consumer companies with pricing power often have commonalities with consumer staples.

“Names that are more staples-like are interesting in this environment,” says Matt Quinlan, senior vice president and portfolio manager at Franklin Equity Group in San Mateo, Calif.

Indeed, consumer staples companies have fared better as consumers typically must absorb higher prices for items they need, reflected in the S&P 500 Consumer Staples index’s performance, down only about 3 per cent this year.

Yet, companies listed on consumer discretionary indexes in the U.S. and Canada that sell low-cost goods have also performed well, including Dollarama Inc. DOL-T. Part of the S&P/TSX’s Capped Consumer Discretionary Index consisting of 14 names, it’s up about 14 per cent this year.

In the U.S, similar stocks like Dollar Tree Inc. DLTR-Q have fared even better, up about 17 per cent this year, and are part of the larger S&P 500 Consumer Discretionary index, which includes 60 companies.

“The key idea is that if economic conditions are getting softer, you want to own less retail or at least more resilient names,” says Mr. Quinlan, lead manager of the Franklin Equity Income Fund.

The strategy also illustrates how the line between consumer discretionary and staple companies is often blurred, Ms. Orlic adds. “Many retail businesses have evolved to straddle both.”

Walmart Inc. WMT-N is a consumer staple company, for example, while Target TGT-N and Costco COST-Q are classified as consumer discretionary stocks.

All three are competitors offering largely the same products, but Target and Costco have seen their share prices fall about 28 per cent and 17 per cent, respectively this year compared with about 11 per cent for Walmart. Inc. AMZN-Q is another diversified retailer in discretionary – though mostly in e-commerce – and its share price has fallen by more 31 per cent since the start of the year.

One reason for the difference in share price performance is Walmart is viewed as more of a budget retailer, Mr. Quinlan notes.

“Walmart also has a much larger mix of food [in its sales] than Target does,” but both companies’ revenue should hold up better in this climate because they sell goods people need, he adds.

Better to be more selective

In turn, advisors and clients may be asking whether the recent rout presents a buying opportunity.

“That’s the big question right now: When to buy those names?” Mr. Quinlan says.

The time is likely not now, he adds, noting discretionary – especially retail – often outperform in the recovery part of an economic cycle.

“I don’t think we’re there because we’re still debating whether there will be a recession next year,” he says.

Still, money managers aren’t entirely shunning the sector. They’re more selective, investing in names likely to remain profitable in adverse conditions.

Cardinal Capital, for example, owns Canadian Tire Corp. CTC-A-T in its Canadian equity portfolio, Mr. Ryall says. Listed among Canada’s few consumer discretionary companies, its share price is down about 6 per cent this year.

He notes it has many qualities that fit with Cardinal’s value mandate.

“Companies that continue to generate earnings are likely to return profit to shareholders either in the form of increased dividends or share buybacks in this climate, and Canadian Tire is a pretty good example.”

He further adds value stocks in the consumer discretionary sector likely have more upside – however modest – than growth stocks in the sector given the current environment.

“It’s not about hitting home runs,” Mr. Ryall says. “It’s about singles and doubles … and that’s where we’re comfortable being right now.”

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 22/02/24 4:00pm EST.

SymbolName% changeLast
Canadian Tire Corp Cl A NV
Costco Wholesale
Target Corp
Walmart Inc
Dollar Tree Inc
Dollarama Inc
Sony Group Corp ADR
Canada Goose Holdings Inc
Tesla Inc

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