Credit Booms - Are U.S. Equity Markets Next?

By Justin Carley - July 11, 2012 | Tickers: AMD, AAPL, F, GM, WYN | 0 Comments

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Real incomes may be grinding to a halt, but that doesn’t mean consumers can’t still spend. The just-released consumer credit report for May indicated that revolving credit expanded at an 11% annual rate!  That is off the charts and is the highest monthly change in absolute dollars since late 2007.  It looks, at least temporarily, as though the spending mentality of the consumer has not been impacted by the deterioration going on in Europe or the looming fiscal cliff.  I highlighted this report back on March 26th as a reason to be cautious of the equity market.  At that time the S&P 500 was at its high for the year and above 1,415.  Shortly thereafter, it would fall 10%, and it currently resides at 1,352.  The most recent report supports the notion that equities can climb the wall of worry as earnings and economic data have the potential to beat recently lowered expectations. 

So what exactly are consumers buying?

Well, they are certainly not buying products housing Advanced Micro Devices (NYSE: AMD) semiconductors.  The company slashed 2Q12 revenue expectations to -11% sequentially from previously stated expectations of +3%.  This is no small decline, and the shares are sliding notably on news.  The main culprit is weakness in China and Europe, a point that I have been covering recently.  Investors should focus their portfolios on equities with high domestic sales and low foreign sales, as the U.S. is poised to be a relative winner for many years.  It is likely that much of the weakness will be attributed to the enterprise division, which along with the consumer spending report, supports the notion of overweight equities with a consumer tilt relative to those with an enterprise spending focus.

Autos, Vacations, and iPads

My gut feeling is that a good portion of the spending is going to autos, vacations, and iPads.  Consumers are seeing the monthly bill associated with a new car as manageable amid ultra-low interest rates.  The recently released June auto sales were quite robust, with a 22% increase year-over-year, on pace to exceed 14 million annually. 

At first blush, investors may think Ford (NYSE: F) and General Motors (NYSE: GM) are two stocks poised to benefit in a strong U.S. car sales environment.  While that is true, the companies each derive about 40% of sales from Europe and Asian operations.  As such, strength in the U.S. is being offset by weakness abroad, especially relative to lofty international sales targets.  These stocks have underperformed year-to-date and investors should steer clear until there are obvious signs that economic growth is resuming in Europe and China.

Spending on vacations, like Christmas, is engrained in American culture and, while there will be slower growth periods from time to time, there will nonetheless be growth.  My preferred name for the year has been Wyndham Worldwide (NYSE: WYN), and I have highlighted it on several occasions.  The company is the largest operator of timeshares and hotels, and while they do have an international flavor, only 8% of their more than 600,000 rooms are located in Europe.  Asia accounts for 9%.  The vast majority is housed in the good ol' U.S.A. 

The stock has done very well this year with a 42% total return, but it still looks poised to continue its outperformance.  Fundamentally, there is a lot to like, with strong dividend growth and a still reasonable 6.5% free cash flow yield.  There is plenty of opportunity for management to fuel the current 1.7% dividend yield amid rising earnings.  The current average consensus expectation for fiscal year 2012 is $3.16 per share, but this is up notably from $2.86 at the start of the year.  The stock remains reasonably valued, although not to the extent it was previously, and it has favorable long-term industry dynamics, a good dividend, and strong earnings trends.

And, of course, living without an iPad or other related consumer products seems crazy to many individuals.  Apple (NASDAQ: AAPL) reported that 11.8 million iPads were sold in the second quarter, a modest 151% growth in year-over-year sales.  The stock has advanced 52% year-to-date and has garnered an almost cult-like following during its parabolic run, which raises a caution flag in my mind.  Still, the valuation and earnings growth remain unmistakably attractive.

Bottom line

Consumer spending for May, while dated in its release, was off the charts.  This will likely reverse to some extent in the coming months but still cannot be overlooked.  The consumer accounts for more than 70% of GDP and, when credit booms, it has a clear spillover into the rest of the economy.  This likely will allow for low hurdles on earnings and propel the markets higher as we head into August.  I do believe this will be temporary, however, as we head into the historically weak month of September, where political bickering and the fiscal cliff take center stage.  Until then, stay invested with companies that have a higher focus on consumer rather than enterprise spending and, of course, those more heavily focused on the United States. 

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