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Pro Analysis

Tom Lee: These consumer stocks will beat market

Pedestrians carry shopping bags through downtown San Francisco.
David Paul Morris | Bloomberg | Getty Images
Pedestrians carry shopping bags through downtown San Francisco.

Fundstrat's Tom Lee recommends consumer discretionary stocks for the rest of the year, predicting the group will outperform the market because of an improving U.S. economy.

"The economic background remains supportive of growth-oriented trades, as the July payrolls, along with solid ISM readings and also recent chatter on fiscal stimulus are positive for risky assets," Lee wrote in a note to clients Friday.

"We are upgrading consumer discretionary to OW [overweight] from N [neutral], as we see an opportunity for this group to outperform the S&P 500 between now and year-end," he wrote.

The strategist cited how the sector's relative valuation to the S&P 500 is currently at a 1.5 standard deviation valuation (forward P/E) discount versus the 15-year historical average. Five out of six times since 2000, when the sector traded at a similar relative valuation level, it turned out to be a "good entry point" for a multimonth rally, according to the firm.

Lee also noticed credit default swaps for the consumer discretionary sector are outperforming the rest of the credit market in the past month.

"The equity has yet to reflect this and as we noted in the past, we believe credit leads equities," he wrote.

Finally, the firm likes how the rest of the Street is negative on the consumer discretionary stocks, which sets up the potential for a mean reversion rally. The current sell-side ratings and short interest level for the sector are one standard deviation more bearish than the average during the last 15 years.

Here are 7 Fundstrat-recommended consumer discretionary stocks with earnings-growth potential next year to take advantage of the call.