Thursday, February 18, 2010

Consumer Stocks Power Ahead

One of the more interesting developments since stocks bottomed last March has been the behavior of consumer discretionary stocks. Consumer Discretionary is a classic early-cycle sector, meaning that it typically performs very well in the early stages of an economic recovery. The reason for this pattern is mostly due to the fertile conditions that exist in the wake of a recession – interest rates have usually fallen to low levels, inventories have been burned off, and consumers begin to anticipate brighter prospects for the future.

In the current cycle, however, there have been a lot of bearish prognostications that consumers will remain dormant for a lengthy period of time due to overconsumption, bloated debt levels, and large declines in asset values that negatively impacted net worth. The implication being that the Consumer Discretionary sector would underperform and should be shunned indefinitely.

It turns out that those investors who stuck with historical tendencies have been rewarded. The chart below shows an ETF that tracks the Consumer Discretionary sector (red line) versus an ETF that tracks the S&P 500 (blue line) since the March 9, 2009 low in stocks. The Consumer Discretionary ETF is up by +89%, compared to +65% for the S&P 500 ETF. The third line (in green) at the bottom measures the relative strength between the two. As it rises, it indicates that the Consumer Discretionary sector is outperforming the broad market. Just yesterday, the relative strength line reached a new high for this cycle, meaning that the gap between the two continues to grow. While no two cycles are exactly the same, the strong performance of the consumer discretionary sector sure seems awfully familiar.