This article was written by Invesco PowerShares Senior Equity Product Strategist Nick Kalivas.
Consumers have long been the fuel that propels the US economy. When consumer spending dries up, so does economic growth. In the 1960s and 1970s, consumer spending made up a little more than 60% of US gross domestic product (GDP). Today, consumers account for more than 70% of GDP. So, it’s no surprise that market participants keep a close eye on consumer trends when making investment decisions. Fortunately, there is plenty of reason for optimism as we enter the second half of 2015. Here are four trends that I believe should support consumer stocks.
1. The housing market has been expanding
Despite the potential for interest rate hikes, the housing market is on the upswing. Existing home sales in May rose 5.1% from April to a seasonably adjusted annual rate of 5.35 million units – the highest level since November 2009. This comes on top of a 2.2% sequential gain in new home sales2 and a 0.9% increase in pending home sales.3 On a year-over-year basis, new and existing home sales were up an impressive 10.7% in May, and pending home sales up 8.3% in May.4
Why are home sale figures a positive indicator for consumer spending?
- Home sales often stimulate consumer demand with spending on furnishing and improvements after the home is purchased.
- The correlation between the growth rate of home sales and core retail sales (retail sales stripped of auto dealers, building materials, supply stores and gas stations) is a relatively high 0.57 since January 1992.1
- Historically, annual growth in home sales predates growth in core retail sales by approximately one year, as illustrated in the chart below.
Given these trends, the strong housing market augurs for retail sales to expand at least into the middle of next year. In addition, a stronger housing market could support housing values and also cause consumers to feel wealthier. The so-called “wealth effect” could, in turn, boost consumer confidence and consumption, in my view.
2. Wage and salary growth have been strong
Wages and salaries increased 5.0% on a year-over-year basis in May, according to the Bureau of Economic Analysis.1 These gains are especially robust given that the May Consumer Price Index (CPI) was unchanged from the previous year. As the effect of low energy prices on the CPI fades, inflation could eventually rise. Even so, so wage and salary growth is vibrant and should provide consumers with continued spending power.
Real (inflation-adjusted) wage and salary growth remains at the high end of a range seen since January 1992.1 Meantime, unemployment claims have remained below 300,000 since February, underscoring strength in the labor market and hinting at continued upward pressure on wages and salaries over the coming year.1
3. Gasoline prices have been cheap
Consumers are also gaining more discretionary income and spending power through low energy costs.
The average price of a gallon of regular unleaded gasoline was $2.81 for the week ended June 22, according to the US Department of Energy – down 24% from a year ago. Gasoline prices have been under $3.00 a gallon since November and should remain below last summer’s prices given ample global supplies of crude oil.
4. Savings are up, debt is down
With the economy gaining ground, Americans have increased their savings. As of May, the personal saving rate in the United States was 5.1%, a figure that has vacillated in recent years. Since the 2008 financial crisis, the savings rate has dipped to around 4.0% on the downside and found strength over 6.0% on the upside. That compares with a savings rate of less than 3.0% during the mid-2000s.1
Correspondingly, household debt is down. The ratio of US household debt-to-disposable personal income was at 102.5% at the end of 2014 (when figures were last available) – a level not seen since during the early 2000s. That’s down from 130% in 2007. 1 The fact that consumers are not under as much pressure to save or pay down debt bodes well for consumer spending. Consumers now have the capacity to borrow and spend if they so desire.
Risks to consumer stocks
Where there is opportunity, however, there is also risk. One potential speed bump for consumer companies rests in higher wages, which could cut into the profit margins of small business owners, restaurant operators and retailers. IKEA recently announced it would raise its minimum wage by 10.3% starting in January 2016, on the heels of a 17% increase that became effective this year.1 IKEA joins the likes of Target, Walmart, McDonald’s, Costco, TJX and Starbucks, among others, in raising corporate minimum wages.5
In addition, profit margins in the consumer discretionary sector of the S&P 500 Index have been above 6.5% in recent quarters, but have not shown much expansion since 2011.1 Fortunately, The bullish news for this sector lies in the fact that margins are high relative to the 1990s and 2000s, and a strong dollar has made the sourcing of goods cheaper. On balance, I expect the positives of the consumer sector to outweigh the negatives, but investors should also be wary of the risks.
After talking to an advisor, investors looking for exposure to the consumer sector should consider the PowerShares DWA Consumer Cyclicals Momentum Portfolio (PEZ), the PowerShares S&P SmallCap Consumer Discretionary Portfolio (PSCD), or PowerShares Dynamic Retail Portfolio (PMR).
1 Source: Bloomberg L.P., June 26, 2015
2 Source: U.S. Census Bureau, June 23, 2015
3 Source: Bloomberg L.P., June 29, 2015
4 Source: U.S. Commerce Department, June 30, 2015
5 PEZ maintained a 2.7% position in Starbucks as of July 2, 2015. PRM maintained a 4.69% position in Costco and a 5.15% position in Target as of July 2, 2015.