Retail spending growth is likely to remain subdued, resulting in a scarcity of opportunities in consumer small-caps, says Morningstar.
Morningstar sector head of consumer Daniel Mueller said investors will need to look to niche areas such as small-caps as the sector continues to achieve low-revenue growth.
Mr Mueller said consumer sentiment has been soft since 2010 and is currently testing six-year lows.
“In our view, consumers became frugal following the GFC because of more conservative attitudes, combined with high household debt levels and falling wages growth.
“These negatives have been supplemented by weak corporate spending, an acceleration of threats from online operators, and international retailers establishing beachheads in Australia.
“We believe this has played into the hands of unlisted online operators and discounters, given their cost advantages over traditional bricks-and-mortar retailers,” he said.
Mr Mueller pointed out that the Australian market is yet to embrace sector headwinds.
“We believe this has led to over-valuation of many consumer discretionary sector names, most of which have no-moat and high uncertainty ratings," he said.
Moreover, Mr Mueller argued that investors are over-optimistic on opportunities in China, “ignoring potential supplier constraints and manufacturing capacity required to meet potentially explosive demand”.
According to Mr Mueller, while the broader consumer sector faces notable headwinds, opportunities exist in “companies in niche areas, not exposed to general Australian retail conditions”.