Are Consumer Discretionary Stocks a Buy?

For most investors, maintaining a diversified portfolio is a good way to help minimize risk and sleep better at night while also making sure that they don't miss out on winning sectors.

Diversification can mean many things -- small versus large stocks, dividends versus growth stocks, and so on -- but most often it's taken to mean spreading your bets among a variety of industries. Of course just because you want to have some exposure to a variety of industries doesn't mean that you want to have the same amount of exposure to all industries.

So what of the consumer discretionary sector? Should we be digging in or pulling back right now? Let's take a look.

Performance
Here's a look at how performance has broken down among the S&P 500 industries:

Source: Standard & Poor's as of May 25.

In the lead-up to the financial crisis, many consumers took out home loans that they couldn't really afford. They ran up their credit cards buying all sorts of goodies. And all along they figured that saving was something you do in the future.

Then the financial crisis hit and suddenly millions were out of work. No jobs, no savings, and maxed out credit cards meant big problems for the companies selling discretionary goods.

But as we climb back out of recessionary territory (and hopefully stay out), consumers are starting to spend again and investors are getting a bit more confident that the consumer discretionary sector will bounce back.

Let's take a closer look
Here's a peek under the hood of some of the major U.S. consumer discretionary stocks.

Source: Capital IQ, a Standard & Poor's company.

Like most other broad sectors, companies that are considered "consumer discretionary" are all over the place and depending on where in the sector you go fishing, you can end up with very different kinds of exposure.

The world of "stuff" can be broken into three categories. First, there are companies like Nike and Polo Ralph Lauren that design and make stuff. Then there are retailers like Home Depot and Amazon that focus on selling stuff directly to consumers. And off in a corner all of their own, there are the auto companies, which include car manufacturers like Ford (NYSE: F), as well as component and part suppliers like Johnson Controls.

There's a similar split in the world of media. On the one hand, there are those companies like Disney that create content, like think Alice in Wonderland and ESPN. On the other, there are companies like Comcast that focus on getting entertainment to consumers.

Finally, we have the consumer services group. Consumer services is largely focused on establishments that serve food and drink -- McDonald's for instance -- as well as hotel and resort companies like Las Vegas Sands and Marriott. But there's a wide variety of other kinds of services that also are included in this group ranging from for-profit schools (Apollo Group) to tax prep services (H&R Block) and funeral services (Service Corp. International).

Putting it all together
To make your portfolio equal weight in consumer discretionary stocks right now, you'd have to have roughly 11% of your assets invested in that sector. And at this point, I think that should be the ceiling for your consumer discretionary exposure.

I don't count myself among those that believe a double-dip recession is on its way. That, however, doesn't mean that I'm particularly sanguine on the condition of the U.S. consumer.

Though generally I think there are better opportunities elsewhere, there are still pockets of opportunity in this sector. Fast food giants McDonald's and Yum! Brands get bonus points because of their low-priced food offerings and focus on growth overseas. McDonald's is a bit cheaper and has a better dividend yield, but Yum! Brands doesn't have Mickey D's exposure to Europe.

I'm also a fan of the Nikes and Polos of the world, as they've created significant moats for themselves by building strong brands, but they're fairly pricey right now. Instead, it may be a good time to look at the much cheaper retailers, particularly those like Target (NYSE: TGT) and The TJX Companies that will hold up better if consumers continue to be pinched.

You don't need technical analysis to figure out the consumer discretionary sector. Besides, technical analysis is stupid.