Improved consumer spending seen fueling expansion

The U.S. consumer will likely be a force to be reckoned with in 2011. Despite punishingly high unemployment, lingering global economic turmoil and endless bickering on Capitol Hill, U.S. consumers appear ready to shoulder the hefty 70% share of the economy they typically bear.

“The consumer is back, and that’s a game changer,” said Douglas Cote, a senior market strategist at ING Investment Management.

Macroeconomic indicators notwithstanding, the holiday retail bellwethers, Black Friday and Cyber Monday, helped bolster the bullish outlook for the consumer discretionary sector as an equity market leader.

Part of the rationale is that if the consumer discretionary sector’s performance is more than double the 11% gain of the broader S&P 500 over the past year, it can continue to lead the index in a stronger economic environment. The 1.2% November increase in retail sales, which was double analysts’ estimates, is another likely preview of things to come, according to Mr. Cote and other market watchers.

“I believe the economic recovery becomes an economic expansion,” he said. “I think unemployment [now at around 9.8%] will be below 9% by the end of 2011.”

BIG VERSUS SMALL

While the consensus outlook generally favors consumer discretionary, technology and industrial stocks, the divergence begins with regard to whether performance will be most prominent among big or small companies next year.

Because various government stimulus efforts are expected to continue, investors should maintain their exposure to smaller companies, according to Quincy Krosby, chief market strategist at Prudential Financial Inc.

“Small-cap stocks have done well, but we’re saying people shouldn’t abandon them yet,” she said. “We’re expecting more stimulus programs from the White House if the quantitative easing doesn’t work, and those attempts to manufacture growth will bode well for small-caps.”

Another factor tilting in favor of small-caps is the record $2.5 trillion in cash sitting on corporate balance sheets, leading most analysts to forecast a wave of mergers-and-acquisitions activity.

“M&A activity will be a strong theme,” Ms. Krosby said. “And that will help small-caps because they get acquired and it puts a premium on other stocks in the category.”

The M&A theme also draws attention to the strength and relative value of large-cap stocks, a category seen by money managers as an obvious choice for performance.

“I don’t think 2011 is a runaway growth story, but it is a recovery story because the fundamentals of the economy are much better than people seem to think,” said Donald Schreiber, chief executive of Wealth Builders Inc., which has $570 million under management.

Mr. Schreiber believes that the market and much of the public are focused on the “fear factor” and are ignoring fundamental signs of strength in the equity market.

“Corporate balance sheets are awash with cash, consumer spending has been better than expected, job growth will accelerate in 2011, and companies will have to keep up with growing demand,” he said.

Citing S&P 500 revenue growth for the four quarters through September of 5.4%, 8%, 10%, and 5%, respectively, Mr. Schreiber said: “You can’t have balance sheet improvement and not have a basis for good economic growth and equity performance.”

The challenge, he added, is sluggish gross domestic product growth and investor fears.

“If the fear factor wanes, I think significant money starts to go into the stock market,” Mr. Schreiber added.

And if history is a dependable guide, investors moving out of more conservative investments will move first toward solid, brand-name, blue-chip stocks.

“I think we’re going to see a tremendous amount of money leaving money market funds,” said Kent Gasaway, president of Buffalo Funds, which has $4.7 billion under management.

While investors will need to be “valuation conscious” as the money flows in and the market performance broadens, the “perception of a better economy” will favor blue chips in the technology, health care and financial sectors, Mr. Gasaway said.

EMERGING MARKETS

Globally, the consumer is also the primary factor driving investment decisions, and many of those decisions continue to involve the fast-growing emerging-markets economies.

“We still anticipate a pretty favorable environment in the emerging markets in 2011,” said Ed Kuczma, an investment analyst for the $380 million Van Eck Emerging Markets Fund (GBFAX).

Stock market performance of up to 25% next year would not be out of the question for some of the hottest markets, including Brazil, Russia, India and China, Mr. Kuczma added.

The strategy’s biggest overweighting, he said, is consumer discretionary in a direct play on the volume of people transitioning into the middle class.

“We’re seeing a lot fewer outdoor bazaars and a lot more indoor shopping malls being built,” he said. “Cars, clothing and washing machines are the kinds of investments we’re gearing the fund toward.”

Mr. Kuczma added that the emerging-markets story is so expansive that it even benefits investors in U.S. multinational companies that increasingly are tapping the foreign markets through acquisitions of local companies.

As the emerging markets have continued their growth trajectory over the past several years, there has been constant debate over how much money and growth the markets can sustain.

“Everybody knows Asia and the rest of the emerging markets will continue to grow, but nobody really knows how much of that is already factored into the stock prices,” said Sam Stewart, chairman of Wasatch Advisors, which manages more than $8 billion.

“In my view, China will continue to be more right than wrong and I think people have been very conservative with regard to investing in China,” he said.

After China, Mr. Stewart favors Brazil, a commodities-rich country that has both suffered and benefited from its close connections to the Chinese economy.

And finally, of his three favorite emerging markets, Mr. Stewart gives a nod to India for its pure growth potential, despite the fact that the market is no longer considered inexpensive by some measures.

Investors will certainly need to brace for volatility, said Mark Mobius, chairman of the emerging-markets group for Franklin Templeton Investments.

EYE ON ASIA

“There will be major corrections along the way, but you’ve got to get used to it,” he said. “In this day and age, a 20% correction is not unusual.”

But instead of focusing on the volatility, Mr. Mobius advises “keeping an eye on what’s happening on the ground” in the specific markets.

While Mr. Mobius suggested dollar cost averaging into some of the riskier markets, he said the emerging markets in general are benefiting from a flood of initial and secondary stock offerings, particularly in Asia, where he is most bullish.

Of the more than $460 billion worth of stock offerings in 2010, more than half was from Asia. The offering volume compares with $260 billion in 2009, when about 60% was from Asia.

“In Asia, you have banks that are being transformed from strictly corporate to consumer banks,” Mr. Mobius said. “We’re pretty excited about all that, and we think Americans should be as excited about Asia as the rest of the world.”

E-mail Jeff Benjamin at [email protected].

Related Topics: ING Group