Time for Investors to Break Out the Champagne? Not So Fast.


It's official. The Dow Jones Industrial Average is trading at an all-time high. Investors are feeling richer as they excitedly double-check their 401(k) balances these days. But despite the giddiness, many Americans are downcast and discouraged. So why this is the case and what implication does it have for stocks?

There are several reasons that investors are rethinking the resilience of the American consumer. Ever since the last Dow record-shattering took place in October 2007, median U.S. household incomes have dropped. And they continue to do so. Last Friday, the government reported a 3.6% drop in personal income during January.

When the payroll tax holiday party ended on Jan. 1, everyone took a roughly 2% cut in take-home pay. Compile that with higher gas prices and the delay in tax refunds and a broader picture comes into focus.

Not surprisingly, consumers are feeling pessimistic and, as a result, revising their spending plans. In January, an indicator of consumer sentiment unexpectedly deteriorated. That bad news was followed by a National Retail Federation survey that reported 70% of Americans were adjusting their spending plans as a result of the increased payroll tax.

Dealing with the pain
Despite the Dow's recent achievement of reaching an all-time high, improvements in the job market, and the housing rebound, this despair may substantially slow growth for companies that rely heavily on our spending. When that spending slows, consumer goods companies feel the pain.

Last month, Wal-Mart's leaked internal emails that referenced "disastrous sales" turned this negative sentiment into reality. While the retailing giant posted solid results for 2012 and raised its dividend by 18%, the company cautioned investors that it expects lackluster results for the current quarter.

Meanwhile, on last week's fourth-quarter conference call, Target CEO Gregg Steinhafel told investors, "While there are some encouraging signs in the housing market, volatility in consumer confidence, the payroll tax increase, and the rise in the price of gas all present incremental headwinds."

But while consumers can typically put off buying larger-ticket items like cars, they can't do the same for toothpaste, soap, and diapers. Consumer staples companies reap the rewards of our dependency on these everyday items. In fact, several of these companies, like Target and Procter & Gamble , have performed well recently.

PG Total Return Price Chart
PG Total Return Price Chart

PG Total Return Price data by YCharts.

Despite deteriorating consumer sentiment, the stocks of these companies have returned roughly twice what the Dow has so far this year. Target has returned nearly 14% year to date, while Procter & Gamble is up more than 11% year to date.

Target reported a slight increase in same-store sales during the fourth quarter. To help fend off U.S. economic headwinds, the company may look for future growth from international stores. Target is expanding into Canada, a country whose economy is growing at a steady pace.

Meanwhile, in late January, household goods giant Procter & Gamble reported much better than expected quarterly results that were led by new products like Tide Pods, strong sales in emerging markets, and ongoing companywide cost-savings programs.

However, the burdens on the American consumer may prompt shoppers to seek cheaper versions of necessary everyday items. As a result, consumers may flock to deep-discount retailers like they did during the most recent recession.

If that's the case, Dollar Tree , which sells every item in its stores for $1 or less, and Family Dollar Stores may benefit from the trend. Lower-end retailer Dollar Tree reported a 2.4% increase in same-store sales and a 26.3% increase in diluted earnings per share for the fourth quarter. Dollar Tree's stock is up roughly 13% since that announcement. Meanwhile, Family Dollar Stores will report earnings on April 10.

Foolish bottom line
Without a doubt, the Dow reaching new all-time highs is exciting. But long-term investors know that market euphoria doesn't last forever. Despite stock market highs, an improved job market outlook, and a recent rebound in housing, slower growth may be in store for companies that greatly depend on our spending.

With the Dow reaching a new all-time high, you may be out of stock ideas. Lucky for you, we've got a great one. The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

The article Time for Investors to Break Out the Champagne? Not So Fast. originally appeared on Fool.com.

Fool contributor Nicole Seghetti owns shares of Wal-Mart Stores, Procter & Gamble, and Target. Follow her on Twitter @NicoleSeghetti. The Motley Fool recommends Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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