by Charlie Bilello | January 23, 2014 12:00 pm
Over the past few years, I have come to defense of the U.S. consumer more times than I can count. By now, we have all heard the litany of negative arguments from the Bears: the U.S. consumer is strapped; workers are dropping out of the labor force like flies; and real income continues to decline.
All the while, though, consumer stocks were acting very well, painting a much more bullish picture than the Bears would have you believe. If the consumer spending was really slowing down, I would counter, why are the consumer stocks leading the bull market higher?
That all changed, though, at the start of this year. The Consumer Discretionary sector (XLY), most sensitive to changes in the economy, has moved sharply lower on a relative basis against the S&P 500 (SPY).
In the chart below, you’ll notice that we last saw similar weakness in 2012 during a 10% correction for the broad market. You’ll also notice that Consumer Discretionary weakness was seen in early 2000 and 2007, well before the cyclical tops were made in March and October of those years.
Now, of course, this weakness could very well be temporary but for now I believe it is prudent to exercise caution here, especially with the equity indices still hovering near all-time highs. Also, if the weakness were stemming from one industry in particular, I could explain it away as an outlier. But that is simply not the case. We are seeing weakness in each of the five sub-industry groups within the Consumer Discretionary sector:
1) First, the Retailing industry group (XRT) has shown the sharpest deterioration over the past few weeks. In the chart below, you’ll notice the relative strength vs. the S&P 500 has moved all the way back to levels from last April. Some of the weaker names in the group include: Target (TGT), Bed Bath and Beyond (BBBY), Best Buy (BBY), Petsmart (PETM), Urban Outfitters (URBN), Sears Holdings (SHLD), and American Eagle Outfitters (AEO).
2) Next, the Consumer Services industry group, which includes restaurants and hotels, is breaking down with its relative strength vs. the S&P 500 back to May 2011 levels. McDonald’s (MCD) is currently one of its weaker members as illustrated in the chart below. If consumers are deciding to pull back from going out to eat at the low-priced McDonald’s, that is not a good sign.
3) The Consumer Durables and Apparel group has also shown a sharp deterioration to start the year. Within the group, we are seeing weakness in homebuilders (PHM, LEN, KBH) and a number of apparel names (COH, RL, FOSL). You would be hard-pressed to find a more discretionary item than yoga gear, and this is reflected in the weakness in the Lululemon (LULU) chart below.
4) Autos are also a highly discretionary group and while they were leaders from May through September of 2013, their relative strength has largely stalled since then (see chart below). The weakest names in the group are Toyota (TM) and Honda (HMC).
5) Lastly, the Media industry group, a leader for much of the Bull Market, has moved down to start the year. Madison Square Garden (MSG) is one of the weaker components, as evidenced by deteriorating relative strength (bottom panel of chart below) since last July.
Overall, this broad-based weakness in the Consumer Discretionary sector is troubling, especially when viewed in light of other risk factors that have been building in recent weeks: defensive leadership and bond strength. U.S. equities have proved their resiliency a number of times over the past year but I doubt they will ignore consumer weakness for long. At 70% of GDP, consumption expenditures are by far the most important segment of the U.S. economy. Until we see improvement here, the risk of a correction is elevated.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
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