Sagging consumer discretionary shares look for a spark

The strength of the US consumer has been often cited as a pillar of the economy and one of the reasons the S&P 500 has recently scaled new heights, but consumer discretionary stocks have skipped the party for several months.

The S&P consumer discretionary sector hit a record high on July 15. But while the S&P 500 has continued to climb to new highs, discretionary stocks have gone in the opposite direction, falling nearly 4%. Subsequent attempts by the sector have fallen short, with the index making lower highs, indicating a downtrend.

The disappointing performance for the sector comes as US companies continue to point to strong domestic spending.

Earlier, data showed retail sales rebounded in October, although purchases of big-ticket household items and clothing were curtailed. Bank of America Merrill Lynch said its US consumer confidence indicator bounced further in the survey period through Nov. 12, but remained below July's levels.

According to Refinitiv data, 65% of the companies in the sector that have reported earnings have topped expectations, below the 74.6% beat rate for the S&P 500 as a whole through Nov. 15. The third-quarter year-over-year earnings growth rate for the sector has tumbled to 0.9% from the 9.9% anticipated at the start of the year.

"Earnings across the board have been pretty lackluster - it may be reflective of the consumer taking a little bit of a pause. Consumer spending has been solid but it hasn't been robust," said David Joy, chief market strategist at Ameriprise Financial in Boston. Research firm CFRA forecasts retail sales for the holiday season months of November and December to rise 4.3% to $1.05 trillion. However, CFRA retail analyst Camilla Yanushevsky believes the growth is more a result of an easier comparison with last year, when figures were distorted by the government shutdown. US consumers are not as strong at this time as they were a year ago, she says.

"This is a very confusing time for investors looking at this sector," said Kim Forrest, chief investment officer at Bokeh Capital Partners in Pittsburgh. "Whither the sales?" A big overhang on these stocks has been the trade war, said Yanushevsky, and the perceived progress in negotiations between the United States and China has been a big factor. Another round of tariffs on about $156 billion in Chinese imports is scheduled to take effect on Dec. 15, raising prices on many consumer products, such as cell phones. Negotiators for the two countries are attempting to reach a deal to cancel current tariffs in phases.

"Right now there is not much optimism; it is kind of a wait- and-see before reacting approach," said Yanushevsky. "If there is some sort of optimism like a Phase 1 deal is signed and then there is a clear path to Phase 2 and Phase 3, that could reignite that optimism that we saw in the beginning of the year with the securities."

Underperformance in Amazon, by far the biggest weight in the sector at over 20%, has contributed to the lackluster returns for the sector. Investors have rotated into beaten-down stocks that have become cheap, such as financials and energy names, which have gained more than 3% this month.

"If you back the lens up and say ' How has consumer discretionary done for the whole year and when did it top out?', it topped out right when we started to cycle into the things that hadn't been working," said Art Hogan, chief market strategist at National Securities in New York.