What Is Consumer Discretionary? Definition in Economic Indicators

What Is Consumer Discretionary?

Consumer discretionary is a term that describes goods and services that consumers consider non-essential but desirable if their available income is sufficient to purchase them.

Examples of consumer discretionary products and services can include durable goods, high-end apparel, entertainment, leisure activities, and automobiles.               

Companies that supply these types of goods and services are usually either called consumer discretionaries or consumer cyclicals.

The consumer discretionary sector of the economy encompasses various industries, the companies of which produce consumer discretionary products. Individuals can focus their investing on this sector by buying consumer discretionary stocks, mutual funds, and ETFs.

Understanding Consumer Discretionary

The purchase of consumer discretionary products is often compared with the purchase of consumer staples. Both product classifications are influenced by cycles of the economy.

In general, when the economy is strong, consumers earn more and spend more on consumer discretionary products. On the other hand, when an economy is contracting, consumers usually earn less and focus their spending more on products essential to their needs. These are known as consumer staples, also referred to as consumer defensive.

Economic cycles have a big influence on earnings power and consumer spending in an economy. There are four stages of an economic cycle. They are defined as expansion, peak, contraction, and trough.

A growing economy—expansion to peak—is usually characterized by stronger earnings for businesses and consumers. This coincides with more spending. A contracting economy—contraction to trough—generally has the opposite effect. That is, weaker earnings and less spending.

When an economy is growing, it is usually expected that consumers will have more disposable income to spend on discretionary items. They'll be less concerned with saving for tough times. This leads to a greater demand for consumer discretionary products.

Alternatively, in a weakening or weak economy, consumers are more likely to forego the purchases of non-essential consumer discretionary products in favor of adding to their savings.

These consumers, however, still need to buy consumer staples—such essential and basic household items as toilet paper, paper towels, food, beverages, and gas. 

Consumer Discretionary and Economic Indicators

There are several economic indicators that help economists to determine the state of an economy. These indicators are also important for predicting trends for the consumer discretionary and consumer staples sectors.

GDP

Typically, gross domestic product (GDP) is the number one metric for analyzing an economy. When GDP is growing, it indicates a strengthening economy where people and businesses are willing to spend more. Conversely, when GDP is decreasing, it is an indication of economic contraction and the need for spending prudence.

Consumer Confidence

Consumer confidence can also be relevant. The consumer confidence indicator can shed light on future consumption and saving behaviors of households. This insight is tied to answers households provide when surveyed about their expected financial circumstances. It's also based on how they feel about economic conditions and unemployment.

Typically in a weakening economy, consumer confidence declines and consumers tighten their belts.

For example, they may postpone vacations and delay the purchase of products that aren't essential for daily living. These products might include high-end clothing, big-screen televisions, and expensive new cars.

The reduced demand for consumer discretionary products is usually a precursor of lower sales for the companies that produce these products. Lower sales can lead to worsening economic conditions and greater economic contraction.

Consumer Spending

The Bureau of Economic Analysis (BEA) releases a monthly report on personal income and outlays. It includes consumer income and spending figures. The latter is known as personal consumption expenditures (PCE). The report also includes the Personal Consumption Expenditures Price Index (PCEPI), a gauge of price inflation that is closely followed by the Federal Reserve (Fed).

The report documents the spending behavior of consumers. In growth phases, personal income and personal spending tends to increase, leading to more purchases of consumer discretionary products. During contractions, personal income and personal spending are usually lower and spending on consumer discretionary products decreases.

Interest Rates

Interest rates can be an interesting metric to follow during all types of economic cycles. In general, interest rates rise in growth phases and fall during contractions. The level of interest rates is important for companies that tap the credit markets for business funding. U.S. monetary policy usually seeks to lower interest rates in contractionary phases to provide a business stimulus.

Other Indicators

Other closely followed indicators that can indicate consumer discretionary trends include the following:

• Retail sales
• Non-farm payrolls
• Unemployment levels
• Labor market hours
• Labor market earnings
• Manufacturing activity
• Services activity
• Home sales
• Building construction activity

Consumer Discretionaries vs. Consumer Staples

When an economy is growing, many sectors see stock values increase and this can make equities attractive. The higher values are due to increasing profits and more discretionary consumer income.

Consumer Discretionaries

• Often, when signs of economic growth or recovery begin to appear, consumer discretionary stocks will lead an upward move in stock market prices.
• Investors who believe a positive spending trend is taking shape may find consumer discretionary stocks a good investment opportunity.
• However, consumer discretionary companies can be sensitive to changes in economic activity and spending behavior.

Consumer Staples

• When an economy is contracting, investors may find consumer staples stocks a solid investment choice.
• That's because companies in this sector produce and sell products that consumers need and buy, no matter the economic climate.
• Consumer staples stocks may even present attractive investment opportunities during a recession.
  

Investing in Consumer Discretionaries

Consumer Discretionary ETFs

Many investors like to put their money into sector exchange-traded funds (ETFs) to navigate through different types of economic cycles. ETFs can limit risks with broadened diversification, while allowing for the concentration of investment positions.

For the consumer discretionary sector, State Street Global Advisors (SSGA) offers one of the market’s top options.

The Consumer Discretionary Select Sector SPDR Fund (XLY) includes the S&P 500’s consumer discretionary stocks. Its top five holdings, as of January 2023, were the following:

• Amazon (AMZN)
• Tesla (TSLA)
• Home Depot (HD)
  
• NIKE (NKE)
• McDonald's (MCD)

For those interested in the consumer staples sector, the SSGA offers the Consumer Staples Select Sector SPDR Fund (XLP). It includes the S&P 500’s consumer staples stocks. Its top five holdings, as of January 2023, were the following:

• Procter & Gamble (PG)
• PepsiCo Inc. (PEP)
• Coca-Cola (KO)
• Costco Wholesale Corp. (COST)
• Philip Morris International (PM)

Consumer Discretionary Stocks

The demand for consumer discretionary stocks normally increases or decreases as the economy grows or weakens. And since consumers typically purchase non-essential goods when they have discretionary income, anything else that threatens that income, such as lower wages or increasing prices, may also affect stock values.

Here are several widely recognized consumer discretionary stocks, in addition to those mentioned above,

• Toyota Motor Corp. (TM)
• HIlton Worldwide Holdings (HLT)
• H&R Block (HRB)
• Autozone Inc. (AZO)
• Macy's (M)
• Thor Industries (THO)

Consumer Discretionary Industries

The consumer discretionary sector consists of a variety of industries that can be sensitive to changing economic conditions and bellwethers of consumer spending. The companies included in these industries react and adjust to changes in consumer discretionary income and purchases of non-essential products and services.

Industry performance is a useful gauge of trends in consumer spending. Consumer discretionary industries tend to thrive when people feel confident about income and spending is strong.

The consumer discretionary sector's manufacturing segment includes automotive, household durable goods, textiles & apparel and leisure equipment. The services segment includes hotels, restaurants and leisure facilities, media production and related services, and consumer retailing and services.

Here are the industries in the consumer discretionary sector.

• Auto Components
• Automobiles
• Distributors
• Diversified Consumer Services
• Hotels, Restaurants & Leisure
• Household Durables
• Internet & Direct Marketing Retail
• Leisure Products
• Multiline Retail
• Specialty Retail
• Textiles, Apparel & Luxury Goods

The Bottom Line

The term "consumer discretionary" refers to non-essential products and services that consumers tend to purchase when the economy is strong, consumer confidence is positive, and individuals have discretionary income to spend.

The consumer discretionary sector of the economy consists of manufacturing and services industries with consumer discretionary companies. Normally, these companies and their industries are sensitive to changing economic conditions.