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Lagging Consumer Cyclical Stocks Remain Overpriced

We expect consumers to begin spending more on experiences, such as travel.

The consumer cyclical sector underwhelmed in the third quarter, with modest returns of 3.8%, leading the broader U.S. market return of 3.2%. The sector slightly lags the market on a trailing 12-month basis, with returns of 35% compared with 36% for U.S. equities.

Exhibit 1: Consumer Cyclical Stocks Slightly Trail the Broader Market

Source: Morningstar

Despite its recent underperformance, we view the sector as slightly overvalued, as it currently trades at a median 4% premium to our fair value estimates. The apparel industry is one of the overvalued industries in the sector at a 3% premium to our intrinsic valuations. We attribute this performance to the fact that many apparel companies have gained from short-term drivers such as stimulus and unemployment benefits as well as fervent demand for activewear throughout the pandemic.

Exhibit 2: We View Apparel Names as Largely Overvalued

Source: Morningstar

While we believe the penchant for apparel will remain robust compared with before the pandemic, we expect near-term sales to normalize in conjunction with consumer spending toward a more sustainable 3%-5% growth rate (as opposed to an estimated 15% for 2021) as early as 2022. During the pandemic, consumers have sought casual apparel to support a more at-home lifestyle. With COVID-19 temporarily closing retail locations and consumers pulling back on discretionary spending, demand for apparel was depressed in 2020. However, as stores began to reopen and consumers resumed shopping, supported by government benefits, outsize sales ensued in the apparel industry. We expect this top-line momentum to decelerate as stimulus and unemployment benefits lessen while demand returns to normal.

Exhibit 3: We Think Sales Growth of Apparel Stands to Moderate Over Time

Source: Morningstar

With the market for discretionary goods like apparel beginning to stabilize, we expect consumers to spend excess savings on experiences, such as travel. Between increasing vaccination rates and the easing of travel restrictions, the industry has been showing signs of a rebound. According to Smith Travel Research, U.S. hotel revenue per available room is hovering around 90% of 2019 levels during the third quarter (through Sept. 18), a notable increase from figures as low as 50% in February. Although business travel has remained mostly dormant due to remote working and the adoption of virtual meetings, we believe that consumer demand for leisure travel will be enough to continue this upward momentum and push travel bookings equal to prepandemic levels by early 2023.

Exhibit 4: Even as Coronavirus Cases Rise, U.S. Hotel RevPAR Nears 2019 Levels

Source: Morningstar

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