Consumer discretionary: Fueled by surprising consumer strength

There’s an old investing yarn that says, “Don’t bet against the American consumer.”

The past year certainly highlighted the threads of truth in that yarn, as consumers proved astonishingly resilient in the face of high inflation, rising interest rates, and increased recession risk. This resilience helped support the stocks of the consumer discretionary sector, which encompasses companies that sell nonessential goods and services like clothes, new cars, and hotel stays.

In 2024, these stocks are likely to continue to rise or fall with the fate of US consumers. Because these companies sell nonessential goods and services, they’re often among the first types of expenses consumers cut back on in a downturn. Yet no matter what lies ahead, I believe the sector can continue to offer pockets of attractively valued stocks, making for some potentially compelling investment opportunities.

Coming off a strong year

Despite the myriad economic challenges, consumer health remained relatively resilient in 2023. Unemployment stayed low. And “real wage growth,” meaning wages after accounting for the impacts of inflation, finally turned positive—thanks to the upward wage pressures of a tight labor market and a declining inflation rate. This helped consumer spending increase over the year, including in the most recent quarter, although it was at a slower pace than the previous year.

In addition to benefitting from a strong consumer, the stocks also benefitted from the same macro themes that helped drive the broad stock market higher in 2023—including relief as the end of the Fed’s rate-hiking cycle seemed to come into view as the year progressed. Sector-level performance was also boosted by unique issues impacting some of the largest companies in the sector. The 2 largest constituents in the sector, by a wide margin, are Amazon () and Tesla (), both of which have experienced extremely strong gains in the past year as mega-cap, tech-related stocks have surged. Both companies have also been seen as potential investing plays on artificial intelligence.

Other segments of the sector also benefited from unique dynamics. For instance, the post-pandemic recovery in travel continued at a strong clip, supporting the stocks of hotels, resorts, online travel platforms, and cruise lines. Meanwhile, homebuilders were helped by constrained inventories, as many existing homeowners decided to stay put due to high home prices and mortgage rates. This effectively redirected buying activity toward new homes, where inventory was available.

Driven by the winds of the economy

In 2024, I believe sector-level performance will likely continue to be driven by macroeconomic crosscurrents. Lower inflation and a pause or end to the Fed's rate-hike cycle could benefit the sector, as consumers might be more likely to purchase big-ticket items such as automobiles or houses. Better still for the sector could be a scenario in which the economy sidesteps a recession and the labor markets remain strong.

If the US does enter a recession and consumers pull back their spending, consumer discretionary stocks could face considerable pressure. The resumption of student loan payments in October, after a long pandemic-related pause, could place added pressure on some consumers.

Potential value in retailers

After the sector’s breakout performance in 2023, stock valuations aren’t as cheap as they were a year ago. But there are still areas of the market where I have found strong long-term drivers, and where stocks have traded at compelling prices. One particular continued area of opportunity has been select retailers. Some of these companies have defensive aspects to their business models, which could provide a degree of insulation if the economic outlook worsens.

For instance, DICK’s Sporting Goods ()² is a leading specialty retailer of sporting goods and active apparel. The company’s investments in in-store experiences have made it a destination for consumers, and this has afforded it a special status among vendors and brands—at times giving it unique access to a range of products that other stores may not carry. The stock has performed well over the past several years (though past performance is never a guarantee of future results). Yet despite that performance, I believe the stock has still been undervalued—including on price-earnings ratios (P/Es) using past actual earnings and P/Es based on analyst estimates of future earnings.

The TJX Companies (), whose businesses include TJ Maxx, Marshalls, and HomeGoods, has felt the pressure of macro headwinds. But the company’s unique operating model could provide strong positioning if the economic outlook worsens. TJX buys up excess inventory from name brands to sell at its low-cost stores. Because low price points are already built into the company’s business model, it may have a degree of insulation against further economic slowing (which can lead consumers to trade down, from higher-priced stores to lower-priced stores).

A long-term focus

To be sure, as we look to 2024 there are reasons for near-term caution on the economic and consumer backdrop. However, as a sector portfolio manager my focus remains on the longer term. Fortunately, consumer discretionary is a wide and diverse sector that can offer pockets of attractively valued stocks. Fidelity's research insights can help me uncover those companies with strong risk-reward profiles and long-term growth potential.