NEW YORK (Reuters) - Consumer discretionary stocks entered the quarterly reporting season on a hot streak: The sector, up for three weeks, is the best performer this year, and earnings expectations are the most optimistic for any sector. But some early results and closer analysis suggest investors should tread carefully.
Most of the gains have been in online retailers and auto parts companies, and fewer than half the companies in the sector have advanced at all this year.
Furthermore, some early earnings reports have not been encouraging. With about 20 percent of consumer discretionary companies having reported their third-quarter results, a majority have failed to meet expected sales growth targets, even as more than half beat profit forecasts.
As Wal Mart Stores Inc (WMT.N) demonstrated dramatically last week with a disappointing earnings report and its worst selloff in a quarter century, traditional retailers are facing challenges.
Additionally, a tepid U.S. retail sales report showed that an expected big bump in spending, due to cheap oil and an improving economy, has yet to transpire amid sluggish world growth and a strong dollar.
"The idea of buying the group because the normal economic model says that when unemployment drops and economies expand, discretionaries and retailers are great buys - it is not proving to be as true unless you have the right names," said Rick Meckler, president of investment firm LibertyView Capital Management in Jersey City, New Jersey.
Analysts have the highest hopes for internet-savvy companies that target higher-income consumers and are somewhat buffered from wage and currency pressures.
Overall, they continue to be enthusiastic about the sector, making the case that an improving U.S. economy coupled with falling gasoline prices should give consumers more disposable income to spend.
"The early indications are they will probably be one of the bright spots in terms of year-over-year growth," said Sameer Samana, global quantitative strategist at Wells Fargo Investment Institute in St. Louis.
Indeed, earnings per share in the sector are expected to grow 10.7 percent over the same quarter last year, making it the strongest of all 10 sectors on the benchmark S&P 500 index .SPX.
The S&P consumer discretionary index .SPLRCD has appreciated about 9 percent for the year, easily outperforming the 1 percent decline in the broader S&P 500. The narrower S&P retail index .SPXRT has jumped about 19 percent this year.
But retailers like Gap Inc (GPS.N), which has lost about 37 percent, Staples Inc (SPLS.O), which has shed 30.7 percent, and Bed, Bath & Beyond (BBBY.O), down 23.5 percent, have seen their shares suffer this year, and serve as a warning to investors expecting gains throughout the sector.
On the flip side, much of the group's advance has been powered by direct online retailers such as Netflix (NFLX.O), which has rocketed more than 100 percent this year, Amazon.com (AMZN.O) up over 80 percent, and Expedia (EXPE.O), up nearly 50 percent, representing three of the top four gainers.
Also showing well were auto-related retailers such as O'Reilly Automotive Inc (ORLY.O), up more than 30 percent, Advanced Auto Parts (AAP.N) and Autozone (AZO.N), up nearly 20 percent each, which have been helped by near-record strength in auto sales.
"Cars are on the road more, people are driving more because gas is cheap, and there is more wear and tear," said Stephen Massocca, chief investment officer at Wedbush Equity Management LLC in San Francisco.
Kim Forrest, senior equity research analyst, Fort Pitt Capital Group in Pittsburgh, likes Urban Outfitters (URBN.O), despite its 20 percent share price drop this year, because it has had success selling high-end clothes.
Editing by Linda Stern and Bernadette Baum