Consumer Discretionary is Not What You Think!

by | Jul 14, 2023 | Podcasts

Consumer Discretionary is Not What You Think!

When most folks think of “consumer discretionary” companies, the names they might think of are names you “could live without.”  And if we entered into an economic slowdown, you might “pass” on shopping with some of these companies.

But when look under the hood, what the market considers to be consumer discretionary stocks – might surprise you!

As we begin the podcast episode (episode #446), we start with a question.  Could 6-7% mortgage rates become the new normal?  And what kind of impact could higher mortgage costs have on how consumers choose to spend their money, and the impact on consumer discretionary areas of the economy.

Join Tim and Tom as we explore this intriguing possibility in our discussion on the current state of mortgage rates, based on an insightful article by Bill McBride. We examine how Bill has become the yardstick for what’s going on in the real estate industry and how his headlines have evolved over the years.

Additionally, we compare the current situation to what happened in 1994 and the idea that history often rhymes, sharing our thoughts on the potential for refinancing mortgages in the future and how it depends on the economy.

In the second half of our episode, we dive into the world of stock forecasting and market sectors, taking a close look at consumer discretionary stocks and how they are affected by changes in mortgage rates. Using examples of consumer discretionary companies like Tiffany’s and American Express, we discuss how people might make cutbacks in their spending if their mortgage payments increased. We also explore the top 10 positions in the Vanguard, iShares, and SPDR Consumer Discretionary ETFs, to help you better understand what Mr. Market considers discretionary. Don’t miss this informative and engaging episode!

Catch all of the Mullooly Asset Management podcast episodes right here on our website!

 

Links for “Consumer Discretionary is Not What You Think”
Bill McBride & his website: Calculated Risk
Vanguard Consumer Discretionary ETF – not a recommendation to buy or sell!
iShares Consumer Discretionary ETF – not a recommendation to buy or sell!

 

Transcript / Timestamps for Consumer Discretionary is Not What You Think!

Tim Mullooly:Welcome back to the Mullooly Asset Management Podcast. This is episode number 446. This is Tim Mullooly, and with me today is Tom Mullooly. Tom, are we recording at night or during the day?

Tom Mullooly: I can barely see you through the smoke.

Tim Mullooly: So for those listening, there’s some forest fires in Canada that are making things very hazy and smoky and it’s kind of disorienting looking outside right now Orangey yellow, it looks like outside has one of those filters on it that makes pictures look like they’re from 100 years ago.

Tom Mullooly: Exactly, everybody wants to come down to the Jersey Shore in June, I guess.  And so does the smoke. Here you go.

Tim Mullooly: Let’s dive into the topic-du-jour. There’s some articles that we want to use kind of just as a jumping off point for today’s conversation, And it has to do with mortgage rates. There’s an article from Bill McBride that we’re going to link to on the show notes. He’s asking the question is these 6% to 7% mortgage rates on 30 year mortgages the new normal?

Tom Mullooly: The first thing I’ll say is if you are a realtor or if you follow the real estate market at all, you need to follow Bill McBride. He put out some good stuff. He put out great stuff and he was a mortgage banker and in 2004 he began writing about what things he was seeing unfolding in the mortgage market in California And he was the first person to publicly write on his blog about the risks that were being taken in the mortgage markets, how they were going through these no doc loans and pulling out home equity and liar loans and all kinds of things. His blog is calculated risk and he became a legend by the time 2008 rolled around, and now Bill McBride is the yardstick for what’s going on in the real estate industry And his headlines have morphed into more than just what’s happening in terms of real estate sales. He gives everybody a really good feel for what’s going on in real estate and that’s such a big part of our economy here in the United States. So an article that he wrote I think it was out today Talked about mortgage rates.

Tim Mullooly: And he’s just wondering the question that probably a lot of people out there are thinking about, you know, are these rates that are 6% plus, are they going to stick around for a long time? Is this going to be the new normal? You know, we don’t know necessarily how long rates are going to be here at these, at these levels, but we know historically where they’ve been and he had a chart on the on the post that illustrated the last decade or so where rates were before the pandemic and they were somewhere in the in the ballpark of three and a half to five percent, maybe a little over five percent. You know he’s not saying that we rates are going to come back down to below three percent or three percent where we were before the pandemic. These levels that we’re at now are certainly higher. It might stick around for a little bit longer than people were anticipating. I’m sure there are people that have bought houses in the last year or so that thought, well, it’s okay, I’m only going to have this six and a half, six point eight, seven percent mortgage for hopefully less than a year and then I’ll get to refinance it when the rates come down and it’s just not happening as quickly as people would like.

Tom Mullooly: I agree and I think that that was part of the pitch that we heard from a lot of real estate and mortgage related people was get the house, get the property. Yeah, you’ll have to carry a higher interest rate mortgage for a year and then you can refinance.

Tim Mullooly: One mortgage broker said to me that you date the rate – and you marry the house.

Tom Mullooly: So as long as you’re in love with the house.

Tim Mullooly: The rate is temporary. I guess it was the point there That may just be the title for our podcast. Yeah, it’s true that you definitely can refinance at any point and rates will probably be lower at some point in the future, but I’m not going to sit here and say by the end of 2023, rates will be X or rates will be Y.

Tom Mullooly: We don’t know. I think one thing we can say, and again, not with 100% certainty, but I think we are pretty confident in saying we are not going to see a two and a half percent mortgage unless we have an economic disaster on our hands.

Tim Mullooly: And, as of right now, it doesn’t appear that we do have an economic disaster on our hands. Different areas of the economy have been hit in different ways. You know, kind of before we turned the mic on it, we were discussing how you had likened what’s going on now to what happened in 1994 and how we kind of had what they coined a rolling recessions, where downturns in the economy in certain industries came and went at different times and not everything went down all at once, and we might be seeing a little bit of that currently. We saw big technology names get hit pretty hard last year, you know, and it’s slowly making its way to. you know, some retailers are not doing as well this year, seeing companies like people off.

Tom Mullooly: There is a lot of truth in this saying that history doesn’t repeat, but it often rhymes. I really believe that because I heard in 1994, late 94, going into 1995, the theme was (if you’re a market strategist) “well, we didn’t get the interest rate call right. In fact, we totally whiffed on it. However, we really feel that there is some kind of slowdown in the economy, and so they came up with this term rolling recession. Whereas Tim just described, one sector will go through a period of slowdown and then layoffs, then they will restructure. Then they’ll forecast better times ahead, and then it, like a virus, it spreads to another sector. So say, it goes from technology to real estate, to the consumer, to all of these different sectors, as it rolls through the economy, and then, a year or two later, people look back and say, well, the stock market’s a lot higher, we never went into a recession. Everyone just forgets about the idea or the concept behind rolling recession. Well, lo and behold, nearly 30 years later, You listen to Bloomberg in the morning, and what are they talking about?

Tim Mullooly: Rolling recessions.

Tom Mullooly: Here we are again.

Tim Mullooly: Because it’s tough to really put a blanket over a recession for the entire economy. Of course there have been times where that has been the case, but you look at what’s been going on over the last year or so and you can kind of poke holes in that, saying, well, these sectors, this area of the economy is doing just fine. What do you mean? we’re in a recession. We’re not in a recession.

Tom Mullooly: One of the commentators on Bloomberg just this morning pointed out for months now we’ve heard the recession is just around the corner,

Tim Mullooly: Over a year of that, I feel like, since around this time last year it’s been that’s what we’ve been hearing. So slow down, sure. Recession? Maybe not. Or targeted, targeted recessions. It depends on what companies or what sectors or what industries you’re talking about.

Tom Mullooly: You’re right. Let’s swipe another headline from Bill McBride. The number of mortgage applications in the past week is down again, something like one and a half percent. That also indicates a slowdown in home purchases. Yeah, that doesn’t even include refinances, right, I can’t see too many people going through a refinancing now because they may be sitting on a 3% mortgage or 3.5% mortgage.

Tim Mullooly: They’re going to be refinancing into something that’s almost seven – double! Almost guaranteed to be refinancing to a higher rate in some capacity. Right, so it doesn’t it doesn’t make sense for a lot of people right now.

Tom Mullooly: So we’re seeing mortgage applications go down. We’re seeing interest rates on mortgages new mortgage creation starting to hover around 7%. The next thing that we hear on the financial media is that this “should hurt the consumer, because they have less discretionary dollars to spend, because more money is going each month towards the mortgage.

Tim Mullooly:  think keyword there is that it “should doesn’t necessarily mean that it’s going to. But when we were thinking about that and what should be hurt in a scenario like that, we were talking about discretionary spending and what gets labeled as consumer discretionary stocks and companies that are in that sector that you would, you know, imagine would also take a hit. If the consumer is taking a hit, then that means the discretionary stocks would take a hit, right?

Tom Mullooly: I would think so. So for our listeners out there, I want you to just imagine for a second, as you’re listening to this, what would be a good example of a company that has discretionary products. I’ll give you my own example in a moment. Just think for a moment: what’s something that a consumer can do without, right? Like, hey, we’re in tough times or, you know, our mortgage is costing us almost twice as much as it used to. We have to cut back somewhere. What can we eliminate? That would be a consumer discretionary company. In my book, the idea, the textbook definition of a consumer discretionary company, Tiffany. Yeah, maybe you want to buy a piece of jewelry or a necklace, something, a bracelet, as a gift. Do you have to go to Tiffany’s?

Tim Mullooly: There are other likely cheaper options out there. Maybe vacations, travel companies, things like that You might cut back there. You don’t necessarily need to take a trip or fly, you could drive somewhere close by.

Tom Mullooly: American Express would be an example, since they’re a travel-related company. Maybe that would be an example of another discretionary company. It’s interesting, though, because what you and I talk about as consumer discretionary doesn’t match up with what “Mr. Market thinks is consumer discretionary.

Tim Mullooly: So if you had the thought of what we were just talking about, where you see this coming, you can foresee it coming and you think these consumer discretionary stocks are going to do poorly. you want to make sure that you don’t own any sort of consumer discretionary ETFs or mutual funds. There are a number of different investments out there that you could choose from that are consumer discretionary that should be filled with stocks that fit the bill of what we just described. However, we were looking at some consumer discretionary ETFs just to see, one, how they’re doing, and two, look under the hood and see what kind of companies do these own, just for some good examples of what you think a consumer discretionary stock might be while we were having this conversation.

Tom Mullooly: We took the three largest consumer discretionary ETFs and we looked at their top 10 positions compared against each other. Tim, I’ll take the first one, which is the Vanguard Consumer Discretionary ETF And, before we get into any of this, understand that Tiffany’s, American Express or any of these companies that we’re about to mention are not recommendations, but we just want to go through the list and compare these names and see if Mr Market thinks of discretionary companies the same way most people would. The Vanguard Consumer Discretionary ETF. Ticker symbol VCR, because VCR used to be a discretionary item Interesting. You can’t even buy them now. Here’s the top 10 positions in the Vanguard Consumer Discretionary ETF. Amazon. I don’t think that’s discretionary, Just my opinion. People shop every day. That Amazon truck is parked on our street.

Tim Mullooly: I don’t know about your street, Tim, but it’s parked on our street every single day, i think there might have been a point in time where Amazon could have been considered a discretionary stock, but yeah, at this point I agree. People rely on that for food, shipments of food and household supplies, and literally everything that they fill their house with.

Tom Mullooly: First position, Amazon. Second, Tesla. Now, maybe, maybe, maybe that’s a consumer discretionary stock. Maybe I’ll get a Chevy instead of a Tesla. It’s kind of lost its cachet as the prices have come down and more and more people are interested in electric vehicles. Amazon, Tesla, third company in this Vanguard ETF – Home Depot, next one McDonald’s, next one Nike, followed by Starbucks. Now, Starbucks might be a discretionary company. Yeah, hey, I don’t need to buy a $5 latte, right.

Tim Mullooly: I think as you go down the list here too, even more lows similar to Home Depot, Bookingcom, TJ, Maxx, Target. I could see how you could make a case potentially, for these to be consumer discretionary, but they’re not the standout names that typically come to mind. So with these, in fact, you could also make an even just as compelling case that they should be the opposite.

Tom Mullooly: They should be staples.

Tim Mullooly: Places that people go during tough times because they are affordable or because they are right around the corner or convenient to go to or have things that you need. We could sit here and dissect each company and be like well, technically it fits because of this, or it doesn’t fit because of that.

Tom Mullooly: It’s not. You can’t compare them to a Tiffany, Right? I’m going to run down this list very quickly and then Tim’s going to talk about the iShares ETF.

Tim Mullooly: I mean, they’re all the same. The only names on there that are different across any of these ETFs, or Netflix is, on one of them, Costco. Other than that, they’re identical.

Tom Mullooly: They’re all pretty much the same stuff On the iShares ETF. Costco and Walmart are on there. I can’t see people saying, hey, I have some discretionary dollars that I may or may not have to spend. I won’t go to.

Tim Mullooly: Walmart this month. Yeah, I need to cut back on my Walmart spending. That’s again. it’s the opposite case.

Tom Mullooly: Then there’s the State Street ETF, which has nine of the same positions that Vanguard ETF has. The only difference there is the last name on their list, Chipotle. I don’t know. To a lot of people they won’t cut that out. They would rather go there.

Tim Mullooly: I think you could make a better case for cutting out Chipotle than some of these other company names. No-transcript. For me, the point here is that trying to time, or trying to pick sectors and forecast where what, in trying to figure out what areas of the market are going to do well or do not do well, depending on economic data that may or may not happen is just incredibly difficult, especially if your understanding of the sector that you’re trying to target is not the same as the understanding of the people that make up these ETFs. So you could have all the thought process there of everything we outlined economy bad, consumer hurt that means consumer discretionary is going to do poorly. And then you know you sell your consumer discretionary funds and it ends up they end up doing really well because the companies that they owned. You didn’t look under the hood and you didn’t realize that, wait, these aren’t really the same stocks that I thought they were.

Tom Mullooly: Yeah, there’s a lot of these. Like we said before, they’re consumer staples.

Tim Mullooly: Yeah, I think it’s difficult to pick out sectors like this based on what’s happening in the economy, and say this one’s going to do well, this one’s not going to do well, and at what times. It’s just very difficult to do that, even as professionals, let alone the everyday investor at home trying to figure this out on their own. So I think ultimately it lends itself to the point of diversification and kind of just trying to stay away from picking out different sectors of the market or timing different sectors of the market based on anything that’s going on currently in the economy. So if we had to sum all of that whole discussion up into into one major point there, I think that would be it. That’s going to wrap up episode number 446 of the Mullooly Asset podcast. Thanks for listening. We’ll see you next time.

Speaker 3: Tom Mullooly is an investment advisor representative with Mullooly Asset management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset management may maintain positions in securities discussed in this podcast.

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