In line with the theme of the previous post, I am going to illustrate a thought process that anyone can employ.

One of the hallmarks of a strong economy is the strength of the consumer sector, especially in what is labelled as ‘consumer discretionary’.  This sector encompasses companies that sell consumables or luxuries, including such things as toys, specialty apparel, travel and tourism, furnishings, gambling and other recreational services, things people want.  We can understand that confident consumers will drive these companies’ profits higher.

When the consumer is less optimistic, he is likely to be spending money on what are labelled ‘consumer staples’. This group of companies would include non durable household products, food retailers and wholesalers, personal products, distillers and tobacco companies and drug retailers.  These companies provide goods that people need and are not luxuries.

For interest we observe the chart of the consumer discretionary versus consumer staples and the pattern is telling.

We notice that the strength of discretionary vs that of durables has actually been on the decline beginning in the middle of 2018.  The selloff in mid February of this year only served to exaggerate the relative underperformance of discretionary.  While the statistic has climbed back to the pre sell off level, it is still not where it was before the market collapse.

Drilling down to have a look at the best performers in the staples category, we see that there has been strong performance in Clorox, CLX, Reynolds REYN and Kimberly Clark, KMB, likely all related to COVID.  Also benefitting are grocers Kroger, KR and Costco, COST. 

On the discretionary side,  there have been very few companies making new highs, (as you’d expect) even with strength in home improvement stores such as Home Depot, HD and Lowes, LOW.   Shoe retailers like Nike, NKE have been only so-so which belies the reluctance of people to spend on such ‘luxury’ items.  Of course, airlines and hotels have fallen off the map. Even Starbucks, SBUX has only struggled to recover.

In assessing the state of the two industry groups and the area of resistance at which they now reside, it is logical to expect that discretionary stocks will continue to struggle here and hence should not be the first areas to look  for investments.  It looks likely that staples will relatively outperform and therefore searching for good chart patterns in those areas makes more sense.

The larger implication of a weaker consumer discretion sector will also impact the strength of markets over the next year as consumer confidence and ability to spend are necessary to revive upside market momentum overall, thus this ratio should be closely monitored.