Sector classifications are meant to help investors make sense of the market. But as Sean Peche, Portfolio Manager at Ranmore argues, when you dig into what’s really inside them, they often create more confusion than clarity.
“I see you’re overweight Consumer Discretionary – you must be very positive on consumer spending,” remarked a client. No, don’t conclude that, we question the usefulness of Sector classifications. Especially for Consumer Discretionary.
“Well, look at the MSCI World Consumer Discretionary Index factsheet & you’ll see the largest constituent is Amazon.” Yes, because they’re retail. Except 58% of their operating income is from their cloud business, AWS. Microsoft also has a large cloud business (35% of OI), but they’re in the Information Technology (IT) sector. And Alphabet also has a large and growing cloud business, but they’re in the Communication Services sector. “Well, that’s because of Search and Advertising.” Yes. Except Advertising is also a big earner for Amazon.
But aren’t the goods that Amazon ship, Discretionary? Yes, but then the other “goods shippers”, UPS and Fedex, are in the Industrial Sector. And you know those credit cards you use for your Amazon purchases? Yes. Well, Visa and Mastercard are in the financial sector. But only since 2021. Before that they were Information Technology Sector companies….
You’d think expensive Apple iPhones are Consumer Discretionary items. But no, they’re Information Technology. Whereas Sony with their expensive Playstation is Consumer Discretionary. Except Playstation game makers like EA are Communication Services… Every tried communicating with a teenage gamer? However, not all game companies are treated this way. Mattel is Consumer Discretionary.
Food retail is Consumer Staples. But “pet food retail” like Chewy is Consumer Discretionary… don’t tell Fido. Booking.com is Consumer Discretionary sector. Because holidays are discretionary? Yes, except the airlines people use to go on holiday are in the Industrial sector.
If you’re as confused as me, let’s talk weightings. Amazon & Tesla comprise 40% of the weighting of the Consumer Discretionary Index. But if Consumer Discretionary offers a clue to the Consumer, you should be very concerned that Tesla’s sales were down 12% last quarter.
Perhaps the only thing that’s “Discretionary” is whether to pay any attention at all to sector classifications.
By Sean Peche, Portfolio Manager, Ranmore Fund Management
