Carl Noble+   |   May 31, 2012

Since the stock market made its recent high on April 2^nd (in the S&P 500), there has been a noticeable shift in sector performance. As they often do during periods of market indigestion, defensive sectors such as Health Care, Consumer Staples, and Utilities have been outperforming. Meanwhile, the cyclical sectors of the market that had previously been leading are now underperforming. The notable exception among cyclicals is the Consumer Discretionary sector, which not only continues to outperform the broad market even during this correction, but is the best performing sector this year by a decent margin.

As the name implies, the Consumer Discretionary sector consists of companies that are leveraged to discretionary spending, which is funded by the portion of income left over after covering bills and other essential spending. They operate in industries like retail, housing, restaurants, leisure, entertainment, etc.

Interestingly, despite still high unemployment and soft wage growth, there are some bright spots for consumers. For example, the household debt service ratio (see below), which is an estimate of the required payments on outstanding mortgage and consumer debt as a percentage of disposable personal income, has fallen from a high of nearly 14% down to 10.8%, the lowest since the early 1990s. This is partially due to the effect of much lower interest rates, mortgage writedowns, etc., and suggests that there’s less of a burden on consumers from these types of payments, and thus a boost in spending power. In addition, in recent weeks the average price of a gallon of gasoline has fallen by more than 30 cents, also resulting in more spending power for consumers.

The bottom line is that Consumer Discretionary stocks continue to be a bright spot in this market, much to the surprise of some observers, and is a sector that we believe still offers attractive investment opportunities.