Consumer Discretionary

Special Report

The self-driving car, or Autonomous Vehicle (AV), will have a profound impact on a variety of industries. However, expectations for the timeframe of commercial AV availability are too optimistic. The greatest near-term impact is likely to be from advanced safety technologies developed on the path to full autonomy. In today's <i>Special Report</i>, we discuss our expectations for the timeframe of AV development, and the effect of advanced safety technologies on the Insurance, Health Care, Semiconductors, and Automotive industries.

Special Report

The self-driving car, or Autonomous Vehicle (AV), will have a profound impact on a variety of industries. However, expectations for the timeframe of commercial AV availability are too optimistic. The greatest near-term impact is likely to be from advanced safety technologies developed on the path to full autonomy. In today's <i>Special Report</i>, we discuss our expectations for the timeframe of AV development, and the effect of advanced safety technologies on the Insurance, Health Care, Semiconductors, and Automotive industries.

Our bearish thesis on the S&P cable & satellite index is not playing out. Instead of skinnier cable packages and cord cutting denting profitability, the industry has managed not only to sustain pricing power, but also to increase selling prices at a faster rate than overall inflation. The latest personal consumption expenditures report showed that cable outlays, in real terms, have begun to march higher again after flat-lining for two years. The cable industry has monopolistic properties, enjoying decades of rising 'real' pricing power. Now that real spending has reaccelerated, it will boost the odds that real selling prices will follow suit. One of our fears had been that slowing sales and rising subscriber churn would force cable providers to ramp up investment to retain customers. However, the largest cable distributors reportedly saw their total cable subscribers decline only 1% in the fourth quarter, similar to the loss in the third quarter, reinforcing that cord cutting is ebbing. The downtrend in capital spending-to-sales has been a major driver of the expansion in operating margins. If capital spending is not going to accelerate, then profit margins won't come under much pressure. We made a full shift to overweight in yesterday's Weekly Report. The ticker symbols for the stocks in this index are: BLBG: S5CBST - CVC, CMCSA, TWC.

Equities are back in overshoot territory. We added the health care sector to our high-conviction overweight list, boosted managed care to overweight and put health care equipment on downgrade alert. Buy cable stocks.

Mixed data on housing turnover and new home prices have created some uncertainty surrounding the S&P homebuilders index over the past year, but we continue to see robust upside potential. Home prices are recovering after experiencing volatility in recent quarters, but not to the extent that affordability has been compromised. In fact, the Fed's dovish shift has helped push down long-term Treasury yields, further depressing mortgage rates and supporting housing affordability. The recent surge in lumber prices suggests that underlying construction activity is solid. Importantly, housing starts and real house prices remain well below prior cyclical peaks, underscoring that homebuilding companies should enjoy a prolonged period of decent growth. Moreover, the homeownership ratio has troughed, removing a major drag on the housing market. Any recovery in this ratio could turbo-charge housing demand. The implication is that homebuilders remain a core portfolio overweight. The ticker symbols for the stocks in this index are: DHI, LEN, PHM.

The Fed's recent dovishness represents an acknowledgement of the feedback loop between Fed policy and financial conditions. Expect Fed hawkishness to ramp back up prior to the next rate hike, likely in June.

The Fed's recent dovishness represents an acknowledgement of the feedback loop between Fed policy and financial conditions. Expect Fed hawkishness to ramp back up prior to the next rate hike, likely in June.

Similar to the euro area, Japanese consumer discretionary stocks have a long runway ahead. Japan is the latest country to join the NIRP club following the late-January BOJ surprise move to charge deposit-taking institutions a negative deposit rate. While interest rate suppression has negative connotations for Japanese banks, it should spur demand for discretionary consumer outlays if it breaks the deflationary consumer mindset. The top panel of the chart shows that relative share prices are inversely correlated with interest rates and the current message is to expect a rebound in Japanese consumer discretionary relative performance. Japan's NIRP should also lure banks to focus on loan volumes. Loosening bank credit standards typically boost discretionary spending. Importantly, a wide gap has opened between loan growth and relative share prices, which will likely narrow via a catch up phase in the latter. Meanwhile the Japanese labor market is tight, but this is neither reflected in relative consumer discretionary share prices, nor in relative valuations (third & fourth panels). Bottom Line: Overweight Japanese consumer discretionary stocks. For additional information on global consumer discretionary stocks please read the Global Alpha Sector Strategy report titled "In the Eye Of The Hurricane" at gss.bcaresearch.com.

Unlike in the U.S., current opportunities in consumer discretionary stocks lie in Europe and Japan. NIRP in the euro area will likely prove a powerful tonic for local consumers, and discretionary spending (top panel). The ECB is aggressively easing monetary conditions and is injecting unprecedented liquidity into the banking sector which should entice bankers to extend credit instead of hoard cash, on the margin. In fact, the ECB is squarely targeting banks to grow their lending books and provide breathing room to the economy, especially in the credit-starved periphery. Following the double-dip recession, euro area credit growth is slated to reaccelerate, as the ECB's fresh TLTROs and QE should open the lending spigots (second panel). On the labor front, while euro area unemployment is still running at double digit rates, excess slack is diminishing. The implication is that pent up consumer demand is only now being unleashed in the euro area, which should boost relative share prices (third panel). None of this encouraging consumer discretionary demand backdrop is reflected in ultra-cheap valuations, given that euro area consumer discretionary stocks are trading at a 25% EV/EBITDA discount to the global consumer discretionary index. Bottom line: Overweight euro area consumer discretionary stocks in a global portfolio (see the next Insight).

The outlook for the S&P consumer discretionary sector is bearish. The time to buy this early cyclical sector is when the Fed is embarking on an easing cycle, in a bid to improve the labor market conditions and restart the credit cycle. The opposite is now true, full employment has already been reached, and the Fed is poised to continue lifting interest rates this year. Historically, interest rates have been inversely correlated with relative performance and the current message is to avoid the U.S. consumer discretionary sector (top panel). Credit is a powerful fuel for consumer discretionary stocks. On this front, the recent continued tightening in U.S. lending standards is worrisome, especially given waning loan demand, according to the latest Fed's senior loan officer survey. The broad-based deterioration implies that tighter credit will persist, to the detriment of loan growth (second panel). Finally, relative consumer discretionary valuations in the U.S. are expensive. The bottom panel of the chart shows that the U.S. is trading at a 6% EV/EBTIDA premium to the global consumer discretionary sector. Bottom Line: A below benchmark allocation is warranted for the U.S. consumer discretionary sector, but opportunities exist outside the U.S., please see the next Insight.