BofA Securities U.S. quantitative strategist Savita Subramanian provided 10 reasons for a double upgrade for consumer discretionary stocks – from “underweight,” right past “equal weight” to “overweight” – and a simultaneous downgrade of defensive consumer staples companies. If correct, the call marks a significant shift in market leadership from companies with secular and predictable earnings growth to more economically sensitive stocks.
Reason one for the is that BofA economists now expect a soft landing for the U.S. economy with no recession and resilient consumer spending. Reason two is that active fund managers are ‘maximum underweight’ in the consumer discretionary sector and if it starts to rally, portfolio managers will help push it higher by increasing their weightings.
Reason three, the strategist believes that Federal Reserve is either done raising rates or close to it, and that stable borrowing costs will support consumption. Fourth, the consumer discretionary sector saw more revenue and earnings beats (relative to consensus analyst expectations) than the staples sector.
The fifth support for U.S. consumer discretionary spending, and this may aggravate many Canadians, is that 85 per cent of American mortgages have fixed rates for the long term, often 30 years. This allows most U.S. consumers to dodge the biggest negative effects from rising borrowing costs.
The sixth and seventh reasons for the new overweight in discretionary stocks involves homebuilders and inflation-adjusted wage growth. Discretionary performance often follows homebuilder stocks with a lag and the latter are now up sharply from their October 2022 low. Real wage growth is now positive after two years in negative territory, also supporting spending.
The eighth bullish driver of discretionary stocks is that, after a post-lockdown period of spending on services, goods spending is seeing an upturn. Goods-focused companies make up about 80 per cent of S&P 500 consumer discretionary stocks.
Ms. Subramanian’s quantitative framework ranks all sectors by price and earnings momentum and also valuation. Discretionary stocks currently rank third while consumer staples are dead last. This result forms reason number nine to add discretionary stocks over staples.
The tenth reason for a consumer discretionary stock rally is that negative headlines about the U.S. consumer are overdone. The strategist notes that while the excess savings from pandemic-era fiscal support will run down to zero in early 2024, BofA economists do not expect and significant change in consumer behaviour as a result. Also, household savings and chequing account balances remain high relative to 2019 levels.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: I have held TC Energy (TRP-T) for over 10 years and although I have enjoyed receiving a great dividend (currently eight per cent), I am down almost 18 per cent! The shares comprise less than two per cent of my portfolio. Should I continue to hold, or sell and claim a capital loss against any capital gains? Thank you very much for your investing wisdom. - Salim S.
Answer: It depends on your investment goals. If you’re looking for income, consider holding the stock. The dividend should be safe, although the company did shock investors by cutting it when it ran into financial problems in 1999. I doubt that will happen again, especially as the company has announced its intention to spin-off its Liquids Pipelines operation next year. A dividend cut would erode investor confidence in the plan.
If you are more interested in capital gains you should hold for the short term. The stock looks oversold, as investors worry about the strength of the balance sheet. Many market analysts think the sell-off has been overdone and are looking for a snap back to the $55 range. If you want to exit, that would be the time. --Gordon Pape
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Compiled by Globe Investor Staff