NEW YORK (CNN/Money) - Never mind that they've been stymied time and time again, economists keep on thinking a blockbuster employment report is just around the corner. Investors, to judge by their abiding love of consumer-oriented stocks, are inclined to agree.
Other than tech, consumer discretionary stocks in the S&P 500 have posted the biggest returns over the past year, rising 47.7 percent. With an average price-to-earnings ratio of 25.2, above both the sector's 10-year average of 20.6 and the S&P's current P/E of 21.6, the consumer discretionaries are also one of the most expensive areas of the market.
What's behind the enthusiasm? One common trope on Wall Street is that consumer discretionaries can sport rich valuations in these initial stages of recovery because big earnings growth in the quarters to come will bring P/Es back in line. These are the outfits that we have some choice over whether we buy their wares or not -- retailers, car makers, home appliance manufacturers, etc.
Once we're confident about the economy and job prospects, then we're going to step up our purchases. And consumer discretionary companies are going to be rolling in dough.
But what exactly are we going to be stepping up our purchases from? One surprising factor of the recent economic downturn is that even following Sept. 11 and even during the run-up to the Iraq war U.S. consumers showed no sign of faltering. In fact consumer purchases of big-ticket items -- cars in particular -- have rarely seen such strong growth. During the previous recession they fell sharply.
The reason consumers have been able to keep spending, despite a weakened labor market, is that credit has never been so easy to come by. Along with a mortgage refinancing dynamic that didn't exist in previous economic cycles, and a generous extension of credit from Washington (the budget deficit the tax cut helped generate will have to be paid back some day), there are the generous terms companies are willing to extend to consumers.
Merrill Lynch chief North American economist David Rosenberg points out that the spread between the five-year Treasury and a new car loan has fallen to and average of just 0.8 percentage points since 1997. For the previous 25 years, that average was 3.94 percentage points.
Rosenberg worries that lenders have overestimated the credit worthiness of consumers and that a new job dynamic, where companies would rather spend money on productivity-enhancing equipment than on hiring workers, will bring things to a head in the year to come. The big surge in spending investors appear to be betting on might not come.
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