European consumer-discretionary companies such as Marks & Spencer Group Plc are outperforming consumer-staple businesses including Nestle SA, indicating investors’ forecasts for the region’s economy were too pessimistic.

Investors have pushed shares of the discretionary group higher in recent weeks as concerns about another prolonged recession have moderated, according to Robert Griffiths, a London-based pan-European equity strategist at Royal Bank of Scotland Group Plc. These stocks historically are “early movers” ― meaning they start to outperform as shareholders improve their economic assessments, he said.

“When investors spot signs of stabilization, this is an area of the market that’s early to rally,” Griffiths said, adding that these shares are benefiting from company sales reports and surveys that are beating forecasts.

The Bloomberg European Consumer Cyclical Index, comprised of retailers and automakers, outperformed the Bloomberg European Consumer Non-Cyclical Index by 35 percent from Feb. 24, 2010, until July 5, 2011. It then underperformed by 24 percent through Dec. 19, 2011. Since mid-December, the index of discretionary companies has risen 11 percent, while the consumer-staple index ― which includes Nestle, the world’s biggest food company, and pharmaceutical maker GlaxoSmithKline Plc ― has increased 3 percent.

Investor sentiment toward the cyclical stocks “seems to have flipped” recently, from negative to “a more balanced outlook,” said Jim Stellakis, founder and director of technical research at New York-based research company Technical Alpha. 

“Investors don’t want to sell these cyclical stocks as aggressively as they did over the prior 10 months,” Stellakis said. “This is a shift that’s worth watching.”

Shares of the consumer-staple companies still are trading at a “very significant premium,” Griffiths said. This group is more than three standard deviations above its 30-year average on a price-to-earnings ratio relative to the FTSE 350 Index ―“an infrequent occurrence,” he said. Standard deviations measure how far the current ratio is from its historic average.

“The relative valuation of consumer staples reflects fear among investors that 2012 would see a repeat of 2008,” Griffiths said.

The recent surge in discretionary stocks has been boosted largely by better-than-forecast retail sales last month and a less-than-estimated contraction in euro-area services and manufacturing output, Griffiths said. SuperGroup Plc reported that December sales rose 9.3 percent at stores open at least 12 months, while N Brown Group Plc said sales increased 2 percent in the 19 weeks ended Jan. 7. 

‘Rising and Improving Trend’

So-called like-for-like sales at SuperGroup, owner of the Superdry fashion chain, are showing a “rising and improving trend,” Charles Howes, finance director, said on a Jan. 11 conference call. “I think we’ve had a pretty solid Christmas,” Howes said of the Cheltenham, England-based retailer’s performance.

A euro-zone composite index based on a survey of purchasing managers in manufacturing and services rose to 48.3 in December from 47 in November, Markit Economics said Jan. 4. While still contracting ― as indicated by a reading below 50 ― output was above the estimate of 47.9 in a Bloomberg survey of economists. U.K. service industries grew at the fastest pace since July, to 54 from 52.1 in November, Markit said.

The surveys show “some modest improvement” in the U.K. and mainland European economies, said Howard Archer, chief European economist at IHS Global Insight in London. “At the very least, this has diluted some of the worst fears about how bad 2012 could be for the euro zone.”


‘Signs of Stabilization’

Early “signs of stabilization” still may be countered by mixed indicators of progress, Archer said. While retailers reported strong sales in December, they did so by enticing holiday shoppers with deep discounts and promotions, he said. Consumers may “hunker down and put away their purses and wallets away for the next few months,” which would impair expansion, he added.

The region’s sovereign-debt crisis remains the “key factor” determining expansion this year, said Archer, who is “more pessimistic” about a potential recession in Europe than in the U.K.

“The economic outlook remains subject to high uncertainty and substantial downside risks,” European Central Bank President Mario Draghi said at a Jan. 12 press conference. The same day, the ECB kept its benchmark interest rate at 1 percent following two consecutive reductions of 25 basis points each.
Still, investors may not need solid signs of a recovery to consider pro-growth industries, Griffiths said. As they reassess their forecasts for expansion, this has made the discretionary stocks more attractive, he said.

“We came into 2012 with a bearish consensus about the outlook for European growth, but some early indications suggest we came out of 2011 with more momentum than we thought.”

(Bloomberg)