Restaurants Reflect Consumption Trends (Literally)

 | Jul 23, 2016 | 12:00 PM EDT
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One of the sectors I've never written about specifically is restaurants. The reason is that the margins are slim and there is an almost constant turnover in companies going out of business or being taken private, and being replaced in the publicly traded space by new and typically faddish restaurants that will then run through their fad, fail and be replaced by the next. 

In order to generate returns from speculating in the sector, a full-time commitment is necessary and I've found the time cost in doing so to be too expensive from a lost-opportunity cost basis. 

However, tracking the sector is an excellent way of gauging consumer discretionary spending habits and by extension is a close to real-time way of approximating real consumer confidence. 

The reason I prefer this as a measure of consumer confidence to the various surveys is that what people say and what people do are different and even diametrically opposed. 

The performance in aggregate of restaurants and their stocks is a better indicator of what people are actually doing, rather than just what they are saying.

I track 50 publicly traded restaurants, one restaurant ETF, one food and beverage ETF and three discretionary-spending ETFs that hold restaurants. 

I won't discuss any of the individual restaurants here, but the restaurant ETF is Restaurant ETF (BITE) , the food and beverage ETF is PowerShares Dynamic Food & Beverage ETF (PBJ) , and the three related discretionary ETFs are PowerShares S&P Small Cap Consumer Discretion ETF (PSCD) , PowerShares Dynamic Leisure & Entertainment ETF (PEJ) and Consumer Discretion Select Sector SPDR ETF (XLY)

Relatedly, I also track the National Restaurant Associations "Restaurant Performance Index" (RPI), the latest available of which is for May. 

The reason I'm bringing this up is that all these issues are portions of what I track and I compare the recent past performance to the likely forward-looking macro trends and trajectory. 

As I've been writing about in recent columns, I expect that the long-end Treasury yields will continue to decline into early next year, dragging mortgage rates lower, and setting the stage for a strong housing market next spring, especially by first-time home-buyers. 

If this occurs, one of the trends that should be a part of it is a decline in discretionary spending as the younger generations begin to reallocate personal income to savings in preparation for it to be used for servicing a mortgage. 

This action is independent of both real economic activity domestically and U.S. monetary policy. 

The reason it's important is that a decline in discretionary spending will almost certainly be considered a negative signal for economic activity, but if it occurs in conjunction with an increase in home purchase activity, it will actually be a positive. 

So far there is almost no indication in the capital markets that the trends I've outlined are starting, and much to indicate that it is not imminent either. 

The year-to-date performance of four of the five ETFs listed above is positive between 6% and 12% and on a steady upward trajectory. The only one that is down is the PEJ, by about 1.5%. That's because of its concentration in airline stocks, which have performed poorly due to the rebound in oil prices this year. 

So, there's really nothing yet evident in the capital markets indicating that the consumer shift I've been writing about has begun. 

The RPI, however, tells a bit of a different story. 

Same-store sales and customer traffic both contracted in May vs. April, which is the exact opposite of what should occur at that time of year. The RPI in aggregate has been in decline for about a year and the trajectory for Current Situation & Expectations Indices is negative. 

The dichotomy between what investors think, as is evident in the performance of BITE and the other ETFs, and what restaurant owners are actually reporting and expecting presents a minor dilemma, but I'm not going to read too much into it at this point. 

Logically and pragmatically, however, I put more weight on what restaurant owners say than what restaurant analysts or investors think. 

The point for those of you wishing to track along with me -- whether or not the shift in consumer attitudes toward spending on housing and away from other areas is going to occur -- is to watch the performance of the ETFs listed above. 

In doing so, bear in mind that the traditional market response to a decline in discretionary spending is negative for the economy and housing, but in this case I'm anticipating that it's actually a positive signal, at least for housing over the next year or so.

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