The consumer sector contains a subset of mid- and small-cap companies that have delivered outstanding returns in the past four months, in many cases without the type of positive news that typically would underpin such a rise.
It’s true that investors are becoming more optimistic about the outlook for consumer spending, driving strong performance across the sector. On Friday, the Select Sector Consumer Discretionary SPDR (NYSE:XLY) broke out to a 52-week high, while the Select Sector Consumer Staples SPDR (NYSE:XLP) closed just short of a new high of its own. But why the massive gains in these smaller stocks, which sell everything from snowmobiles to pool supplies?
The short answer: short interest. Much like other high-flying market segments right now (the homebuilders come immediately to mind), all of the stocks in this group have a relatively high short interest:
|Stock||Ticker||Gain from 10/1 Low||1/13 Short Interest|
|Life Time Fitness||LTM||42.5%||21.3%|
|Advance Auto Parts||AAP||36.7%||8.9%|
|Papa John’s Pizza||PZZA||40.4%||3.7%|
|S&P 500 Index||22.3%|
In this sense, the market is acting much as it did during 2003, when a highly accommodating Federal Reserve policy dovetailed with a rebound in investor sentiment from extremely pessimistic levels. This favorable mix helped drive substantial gains in heavily shorted stocks through the middle part of that year. Amazon (NASDAQ:AMZN), for example, tripled from its mid-February low to its October high that year, chopping up any investor who tried to bet against the rally.
So what’s an investor to do with this information?
The primary takeaway for anyone who owns any of the stocks on this list is not to get carried away with the recent gains. Many of these names are at or near three-year highs by several valuation measures, so longs need to be ready to take profits at the first sign of trouble.
At the same time, however, investors who are looking for something to short might be better off looking elsewhere. One of the quickest ways to lose money is to “fight the Fed” — and in this case, the ECB as well — by shooting against momentum stocks with elevated short interest. While many of these stocks are likely to experience meaningful downside at some point in the coming weeks or months, the current level of short interest indicates that it isn’t worth taking the risk of trying to time this turn.
The larger lesson here: Pay attention to short interest. Right now it’s one of the most important considerations that should underpin trading decisions in any stock, and not just this group of outperforming consumer names.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.