As a vital part of the economy that produces non-essential goods and services that consumers buy when they feel confident about the economy, the consumer discretionary sector is highly sensitive to economic conditions and consumer confidence. So, is it an attractive investment option for your portfolio? Should you rather trade companies of the consumer discretionary sector over the short term? Let’s dive in to determine if investing in the consumer discretionary sector is a good fit for you.
What is the consumer discretionary market?
The consumer discretionary market is a sector that includes companies that offer items and services that buyers will turn to when they have higher disposable income, as they are not as crucial for day-to-day life, like food or healthcare are.
Considered as non-essential or discretionary, these products or services are desired by buyers depending on their preferences, objectives, or life philosophy, and can be part of many sectors like durable goods, home electronics, luxury, automotive, as well as travel, leisure, entertainment and restaurants, among others.
State of the consumer discretionary market
The first thing to understand is that the consumer discretionary market is a cyclical market that is highly influenced by local and global growth economies and their prospects.
When financial sentiment and optimism about the future is improving and growth conditions are rising, then people tend to spend more on less necessary items. Therefore, the companies belonging to the consumer discretionary market tend to outperform the market. On the other hand, when people are less optimistic about their personal finances, they tend to save more rather than spend more, which tends to weigh on the consumer discretionary market.
Due to economic concerns linked to rampant inflation, lower purchasing power, and higher interest rates, the consumer discretionary sector has shown weaker performance last year, as investors avoided cyclical sectors. However, the outlook improved in 2023, supporting a risk-affine behavior from investors.
Of course, the sector performance will still be impacted by macroeconomic uncertainties, but things seem to be improving with better global sentiment and confidence from people and companies. Moreover, some stocks are showing attractive valuations with strong underlying fundamentals and a promising outlook.
Among these, home-improvement retailers stand out as an appealing option with their low valuations after their fall in 2022 and positive long-term growth prospects, driven by aging housing infrastructure and inventories, as well as tax incentives for energy-efficient improvements in existing houses.
Consumer discretionary - What are the growth opportunities?
Investors will have to closely follow economic data and statistics that will help them determine the state of a given economy, such as GDP, Inflation, Consumer Confidence, Salary Inflation, and Key Interest Rates, as companies of the consumer discretionary sector will show sign of recovery and increase during economic growth, as spending trends will be more positive.
With the recent rise in prices around the world, companies offering discretionary goods have been avoided by investors, as they were considered risky due to higher uncertainties about the global economy. Therefore, many companies have now reached more interesting valuations.
Now that interest rates in the United States (and maybe in other developed economies) are likely to roughly remain at their current levels as inflation seems to be slowing down, spending habits might change and consumers might spend more on things they like if they believe in a brighter future for them. However, you will have to carefully choose the sub-sectors that offer the greatest opportunities according to your strategy and your time horizon.
With the rise of online shopping, e-commerce has become a significant growth driver for companies in the consumer discretionary sector. Online sales provide companies with an opportunity to reach a broader customer base, reduce costs, and increase efficiency. As a result, many companies are investing heavily in their e-commerce capabilities to capture this growth opportunity.
The consumer discretionary sector also benefits from technological innovation, which is driving the development of new products and services. For example, the use of virtual and augmented reality is transforming the way consumers shop, while the development of new materials is leading to the creation of new products.
Finally, emerging markets present a significant growth opportunity for companies in the consumer discretionary sector. These markets have a large and growing middle class, which is driving demand for discretionary products and services. Companies that can successfully penetrate these markets can tap into significant growth potential.
What are the risks of investing in the consumer discretionary market?
The biggest risk of investing in the consumer discretionary sector is the fact that it is highly sensitive to macroeconomic conditions and consumer sentiment, which can change quite quickly and affect your portfolio, especially if you invest in the long term.
Depending on the sub-sector you’re targeting, the competition can be wide and fierce, so you will need to select companies with a unique market position and a competitive advantage that are able to capitalize on changes in trends and needs.
You should therefore focus on dominant players with solid financial health and a strong track-record, even though smaller companies might also provide great opportunities (with generally more risk).
How can you invest in the consumer discretionary market?
To invest in the consumer discretionary market, you first need to be sure that this market fits your trading strategy and style, as well as your risk-aversion and your financial objectives. You also need to take into account the macroeconomic landscape to determine if it’s the best timing to invest in such a cyclical market, depending on fundamental factors. You can use technical analysis to fine tune your analysis to decide the best timing to enter or exit a position.
Depending on what you’re looking for, there are a range of ways to invest in the consumer discretionary market.
You can target single companies through CFD (Contract For Difference) over the short-term or through non leveraged financial products over the long run. Amazon, Nike, Netflix, Starbucks, Target, LVMH, Kering, Pernod Ricard, Adidas, Hugh Boss, Beiersdorf, Burberry, Unilever, and WH Smith are among the most popular consumer discretionary stocks. Depending on your strategy, you can also use options and futures on consumer discretionary stocks.
If you’re looking for a solution to get wider exposure to this industry, you can use funds or an ETF (Exchanged-Traded Funds). These products can also be used to focus on specific industries and/or countries.
However you decide to invest in the consumer discretionary sector, be sure that it is a good fit for your trading and only invest money you’re willing to lose.
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