Eye-catching quarterly results by Target, Home Depot and other big U.S. consumer names were among the bright spots in a third quarter that was disappointing for many other companies.
Major sellers of discretionary goods posted upside earnings surprises at the tail-end of the earnings season. This helped the S&P 500 stock index end the quarter about even from a year earlier. Analysts had expected companies in the index to post the first quarterly earnings decline in three years.
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Consumer discretionary stocks show signs of strength that much of the S&P 500 does not - double-digit year-over-year growth, a high percentage of companies beating analyst forecasts, and strong growth projections for coming quarters.
"Consumer sentiment has been improving steadily and this is affecting retailers to some extent, and retailers are also getting a boost from consumers getting their own fiscal matters in order," said Bryant Evans, investment advisor and portfolio manager at Cozad Asset Management, in Champaign, Illinois.
The sector's strength is a hopeful sign for the U.S. economy although it does not mean U.S. growth is roaring. Uncertainty about Washington's wrangling over the fiscal cliff, and weak demand worldwide, could change the U.S. outlook in a hurry.
Still, reduced exposure to Europe and other weak overseas markets helped sellers of electronics and home improvement goods outperform the rest of the equity market.
With results in from most companies, S&P consumer discretionary sector earnings are up 12.1 percent from a year ago, the only sector boasting double-digit growth.
Strong consumer sentiment in recent months has boosted retail sales. U.S. consumer confidence rose last month to its highest level since February 2008, according to data from the Conference Board.
The household debt service ratio - an estimate of the share of debt payments to disposable personal income - fell to 10.69 percent in the second quarter, the most recent data available, according to the Federal Reserve. It was the strongest ratio since the fourth quarter of 1993.
By contrast, CEO confidence remains weak. A Business Roundtable survey released in September showed its index of CEO confidence fell to its lowest point since the third quarter of 2009.
AVOIDING A FALL IN EARNINGS
A Thomson Reuters analysis shows earnings growth for 10 of the biggest consumer discretionary companies, including Home Depot and Target, is at 10.3 percent.
This is much stronger than 10 S&P 500 companies with heavy international exposure such as Coca Cola Enterprises and Cisco Systems . These show earnings growth declining 2.9 percent from a year ago.
The euro zone's debt crisis has dragged the bloc into its second recession since 2009 in the third quarter.
S&P 500 earnings for the third quarter are flat from a year ago, even though a majority of companies have missed revenue expectations. Of companies that have reported, 61 percent have missed revenue expectations for the third quarter.
Without consumer discretionary stocks, S&P 500 quarterly earnings would be down 1.1 percent, Thomson Reuters data shows. Analysts had predicted the first decline in earnings since 2009.
The percentage of companies beating expectations in the sector, at 75 percent, far surpasses the 65 percent for the entire S&P 500, according to Thomson Reuters data.
Shares have outperformed as well. The S&P consumer discretionary index is up 14.6 percent for the year, while the S&P 500 is up 7.3 percent.
On Thursday, U.S. retailer Target - one of the 10 largest consumer discretionary names by market value - posted profit that beat analysts' expectations. Wal-Mart , the world's biggest retailer, posted disappointing sales and said store traffic in China declined again. Wal-Mart, a consumer staples stock, derives 28 percent of its sales from overseas.
Surprisingly strong results also came this week from clothing retailers Gap and Abercrombie & Fitch , both of which also raised their full-year outlooks. Gap's stock had already surged this year, up 81 percent since the end of 2011, while Abercrombie's stock surged 30 percent this week.
Many analysts say the mostly stronger-than-expected results from retailers signal that holiday sales could be strong this season despite a sluggish U.S. economy.
"The housing market has been posting some really really encouraging data. That should send nice ripple effects across the economy, a multiplier effect through the consumer," said Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, whose firm manages about $13 billion in assets.
Consumer companies could keep supporting earnings in the S&P 500. Double-digit earnings growth is expected for the sector through next year, Greg Harrison, Thomson Reuters corporate earnings research analyst, said in a recent earnings report.
Earnings for the consumer discretionary sector are forecast to rise 14.3 percent for the fourth quarter as well as for the first quarter of 2013.
"That could be a very nice positive catalyst. Will it be enough to completely offset a severe 'fiscal cliff'? Probably not, but the timing might work out where it could be a pretty significant force," Trunow said.
(Reporting By Caroline Valetkevitch; Editing by David Gregorio)