Surprising Sector Holding Up Best

Since the S&P 500 hit its recent peak of 1,217 on April 23rd, it’s fallen by 13% through yesterday’s closing price of 1,055. It violated (fell below) its longer-term term 200-day moving average on May 20th, and has traded below that important trend indicator since then. Along the way, 9 out of the 10 broad S&P sectors have also fallen through their respective 200-day moving averages (using sector ETFs), essentially “confirming” the weakness in the broad market. Can you guess the one sector that hasn’t broken down in the same fashion yet?

The obvious answer would seem to be one of the typically defensive sectors – Consumer Staples, Health Care, or Utilities. But, those would be all be wrong in this instance. The correct answer is the Consumer Discretionary sector. Consumer Discretionary has been outperforming the broad market since the first credit crisis bottom on November 20, 2008, and has been an outright market leader for much of the time since then.

The reason that the sector’s recent resilience, and its impressive performance for the past year and a half, is “surprising” is that many pundits had written off the consumer as dead, opining that a new era of frugality is upon us as a part of the fallout from the housing bubble and credit crisis. While that may turn out to be true over a longer time period, it hasn’t mattered much in the shorter-term, as the sector has clearly been exhibiting its traditional “early cycle” traits in spite of those sentiments.

Chart: Consumer Discretionary Sector ETF (Symbol: XLY) with 200-day moving average

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.