The Consumer Discretionary Sector: Nice Pair of “B”s

The Consumer Discretionary sector is important.  It makes up 10.55% of the S&P 500 Index including companies from industries such as media, retail, hotels, restaurants, leisure, textiles, apparel, luxury goods, household durables, automobiles, and other consumer services.  It came out of the economic storm of the past three years a shining star, rising an annualized 11.7% per year versus just 0.65% for all 500 stocks in the index and handily beating the remaining nine sectors.  Over the past 12 months, this sector has maintained its momentum and outperformed all others except Energy.

S&P 500 index sector breakdown courtesy of Standard & Poors as if August 15, 2011:
Sector Breakdown

Bulls on the stock market may simply choose to remain overweight the Consumer Discretionary sector within portfolios using a simple Exchange Traded Fund (ETF) like XLY.  Those with the desire and resources to attack portfolios with a scalpel, may choose to own individual securities within this sector. 

Best Buy Co., Inc. (Public, NYSE:BBY) and Bed Bath & Beyond Inc. (Public, Nasdaq:BBBY) are two companies investors visit during their weekend trip to the local strip mall.  Both are classified Consumer Discretionary stocks, but only one is currently in the good graces of investors and consumers alike.  BBBY is up 46% in 12 months and 10% year-to-date.  BBY is down 25% in 12 months and 28% year-to-date. 

One sells electronics and appliances to average Joes while the other sells infomercial novelties and various bed/bath trinkets.  The story isn’t too surprising, given that households have held off on durable goods purchases like TVs and washing machines.  Instead, they line up at BBBY to buy a $50 hand mixer or steak knife.  These impulse buys satisfy the consumer inside us without breaking the bank.  Given the massive divergence in performance, some may argue it’s time to switch gears and move from one position into the other.  

My last Saturday visit to BBBY wasn’t great: empty parking lot; shoppers in checkout line had very few items in their hands; too many gimmicky products.  I didn’t like what I saw at BBY either: empty stores; too much free financing shows weakness; terrible customer service both on the floor and within Geek Squad.  Management for the worse performer of the two, BBY, is no bunch of dummies.  They are capable of fixing what’s wrong as the market picks up for their products.  BBBY’s chart looks like Mt. Everest so perhaps it’s seen its best days, but fear of heights isn’t a great quality in an investor.  There is lots of room for debate here!

Plenty of investors remain sidelined and may not be ready for a Consumer Discretionary bet despite the overwhelming evidence presented by this sector’s performance over the past few years.  They may want to explore the sophisticated “pairs trade” commonly executed by institutional investors like hedge funds.  You simply buy one stock long and sell the other short in identical dollar amounts.  You buy the stock you think will outperform looking forward, and sell the one you think will lag.  Your net exposure to the sector and overall stock market remains zip, zero, zilch.  But you now benefit if the stock you like does better than the one you think is a dog.  This should be a fairly easy experiment to test out with a small portion of your portfolio.  It’s also a great way to stay active when you have an idea about two stocks, but wish to remain on the sidelines with respect to the sector or the stock market as a whole.