Amidst this increasing volatility, stocks that are the most expensive and have been driven by momentum (i.e. the expectation that increases will be followed by additional gains and vice versa) could be the hardest hit.
Market Realist – Consumer stocks could underperform if earnings don’t catch up with expectations.
The graph above compares the price returns of the Consumer Staples Select Sector SPDR (XLP), which tracks stocks from the consumer staples sector, with the price returns of Procter & Gamble (PG), Nike (NKE), and McDonald’s (MCD)—which are all consumer-related stocks—since August 2014. This ETF and this stock have given returns of 12.1%, 2.9%, 30.7%, and 3.3%, respectively.
These returns coincided with the slump in oil (USO) prices. Lower oil prices mean consumers have more money to spend elsewhere. This is usually a positive for consumer-related stocks.
However, as we saw in the previous parts of this series, consumption hasn’t picked up meaningfully. In fact, the last three months have seen a contraction in retail sales (RXI).
The rally in consumer-related stocks means that the markets have already priced in most of the benefits of lower oil prices. If consumption doesn’t improve in the coming months, these stocks could fall hard.
The consumer staples sector is trading close to 21x earnings, while the consumer discretionary sector is trading at ~22x earnings. These sectors have seen multiple expansion due to the high expectations set by the market, and they’re now quite expensive relative to earnings. If earnings don’t catch up in the coming earnings season, these sectors could fall.
Read Why US Consumers Are Hesitant Right Now for more on why consumer-related sectors could underperform.
The next two parts of this series delve into other “momentum sectors.”