Consumer Discretionary received a big downgrade from analysts at Morgan Stanley, and how the tides have changed for the sector this year. The sector led in hedge fund inflows during the second quarter, according to FactSet, but Bank of America Merrill Lynch reported earlier this month that the sector had the longest selling streak among their firm’s clients at 14 weeks.’

Also see Horseman Capital Ready For Bear; Pares Back China Shorts, Details Bet Against Consumer Staples

Meanwhile projections for earnings growth indicate the weakest growth for Consumer Discretionary in years.

Consumer Discretionary downgraded

Indeed, the markets have been in an uproar as portfolio managers’ searches for alpha have come up dry in many cases. Now Morgan Stanley analyst Adam Parker is trying to “atone for his portfolio sins” by upgrading and downgrading sectors and simply moving things around. He upgraded Industrials to Overweight and downgraded Consumer Discretionary to Underweight, in addition to shifting other parts of his portfolio recommendations around.

consumer discretionary

[drizzle]The strategist admitted that his team’s previous portfolio underperformed the market by 6.1% year to date.

Consumer Discretionary hits the skids

Things just don’t look good for Consumer Discretionary earnings-wise either. S&P Global Market Intelligence reports that third quarter earnings for the sector are expected to come in at their weakest growth rate in four years. The firm projects 2.1% earnings per share growth for the third quarter, which is the least amount of growth since the second quarter of 2012 when the sector’s earnings grew only 0.3%. That quarter is notable as well because it was right before the Fed announced its third round of quantitative easing.

In the first quarter of this year, Consumer Discretionary logged a 21.3% growth rate in earnings per share, while in the second quarter, the sector’s earnings grew 14.6%. The downshift to 2.1% growth is a dramatic turn of events, although that percentage will probably rise as the earnings reports start coming in. In most cases, analysts underestimate the growth rates for earnings in the S&P 500, meaning that they rise as the reporting period goes on.

Here’s a look at S&P Global’s current earnings estimates by sector:

2

Utilities over Consumer Staples

Parker said in his October 10 report that among rate-sensitive stocks, he prefers Utilities over Consumer Staples after looking at defensive attributes like volatility-adjusted ROE, volatility-adjusted-EPS growth, and stock price movement. The Morgan Stanley strategist explained that the majority of Consumer Staples stocks are six to eight turns more expensive than Utilities stocks looking at price-to-forward earnings.

He agrees that Utilities shouldn’t trade on par with Staples because of the technology risk and also their lower growth rate, but he believes the premium that has been assigned is too high, especially because Staples may have a hard time achieving estimates in the event of a strengthening dollar. He notes that both groups will probably continue to underperform because the 10-year yield has been rising, and both would probably outperform if the yield falls.

Looking at growth stocks, he prefers Health Care over Technology because he believes the premium being slapped onto software right now is just too expensive for its growth. This is particularly relative to biotechnology, which he believes is cheap compared to its growth rate. He sees the concerns about drug pricing that were raised by the current presidential election as overblown.

[/drizzle]