Consumer discretionary stocks outperform consumer staples in a forward risk signal for the broader market.
The gains in the consumer discretionary sector reflect a robust economy and high consumer confidence.
The S&P 500 correlates strongly with consumer preferences during bull market developments.
The stock market is flashing an under-the-radar bullish signal that suggests the ongoing rally will extend into 2025.
The signal is simple, but powerful: the outperformance of risk stocks relative to defensive stocks has reached record levels.
In particular, consumer discretionary stocks have hit new highs when measured against consumer staples stocks.
Consumer discretionary stocks are considered risky because they reflect non-essential spending, while consumer staple stocks satisfy consumer needs.
It is believed that consumers will continue to buy products from companies within the consumer staples sector even when the economy slows down or contracts. At the same time, they reign in their spending on discretionary items in times of economic distress.
“Defensive stocks tend to lead when there's trouble and we don't see that,” Ryan Detrick, chief market strategist at Carson Group, told Business Insider. “That's a good thing.”
The widening performance gap is a sign that investors are comfortable betting on the consumer continuing to spend their income on goods they don't necessarily need but want, given the economy remains on a solid footing.
The performance gap between the two sectors is striking.
Year to date, the consumer discretionary sector is up nearly 3% compared to a 2% decline in the consumer staples sector.
And over the past year, consumer staples have only grown by 7% compared to a 34% gain for consumer discretionary. The improved performance continues looking back three and five years as well. Meanwhile, the S&P 500 has increased by 2% a year to date and 27% over the past year.
From a fundamental perspective, Arun Sundaram, senior equity analyst at CFRA Research, told Business Insider that a strong labor market has boosted consumer discretionary stocks. At the same time, concerns about GLP-1 weight loss drugs exacerbated the decline in stocks of consumer staples.
“Investors are questioning the long-term impact of revolutionary weight loss drugs like Ozempic on food and beverage companies, which dominate the Consumer Staples sector,” Sundaram said.
But putting aside what's driving the widening gap in performance between the two sectors, this is typical investor behavior in a bull market, according to Sam Stovall, chief investment strategist at CFRA.
“Intuitively, it makes sense that when the consumer discretionary sector rises, so does the S&P 500, as the consumer discretionary sector has a 93% correlation of monthly returns with the S&P 500,” Stovall told Business Insider .
Comparatively, the consumer staples sector has a 73% correlation with the S&P 500, according to Stovall.
This is the kind of behavior investors want to see during bull markets, as it confirms the underlying trend that pushes stocks higher.
“Looking at the sector's returns during upswings and market downturns, consumer discretionary is better during upswings and consumer staples is an underperformer,” Stovall said.
To account for the skewed weight of Amazon and Tesla in the consumer discretionary sector, which together make up about 40% of the sector, Michael Batnick, director of research at Ritholtz Wealth Management, looked at the relative performance of discretionary and consumer with equal weight. staple sectors.
He likes what he sees.
When the line in the chart moves higher, it is a sign that consumer discretionary stocks are outperforming consumer staples stocks, and vice versa when it moves lower.The Compound
“I'm not worried about this sale at alland this is the chart that gives me confidence,” said Batnick in a a podcast this week for The Composite.
Batnick called it “the most bullish chart in the world,” adding that “this is not something you see in a bear market.”
Ryan Detrick, Chief Market Strategist at Carson Group, told Business Insider that the risk-on signal is not limited to the relative performance of consumer discretionary
JC Parets, technical analyst and founder of All Star Charts, echoed the same sentiment when speaking to The Composite and its Friends on Thursday.
Parets provided a long-term chart of the relative performance between the two sectors, showing that the ratio chart is just above a key resistance level identified by the stock market peak in 2007 and 2021.
When the line in the chart moves higher, it is a sign that consumer discretionary stocks are outperforming consumer staples stocks, and vice versa when it moves lower.All Star Charts
Ultimately, that is a risk-on signal that suggests the stock market rally will continue.
“We are not overly concerned that things are falling apart and the end is near as we keep hearing, as the right leadership is still in place,” said Detrick Carson Group.
