Are consumer discretionary stocks the canary in the coal mine?

By Covestor

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The S&P 500 was down only about 1% from its all-time high on Wednesday afternoon yet there are signs investors are getting increasingly nervous before earnings season.

For example, market leaders such as Facebook (FB), Tesla (TSLA) and iShares Nasdaq Biotechnology ETF (IBB) have been shaky of late.

Now, technical analysts who use intermarket analysis are also red-flagging the weakness of consumer discretionary stocks in 2014.

Why does this cyclical sector's underperformance matter? Because consumer discretionary stocks are tied to disposable income and consumer spending patterns, and are therefore viewed by some as a leading indicator of the overall economy.

With a year-to-date loss of 3%, the Consumer Discretionary Select Sector SPDR ETF (XLY) is the worst performer of the nine major sectors. The ETF’s top five holdings are Amazon (AMZN), Walt Disney (DIS), Comcast (CMCSA), Home Depot (HD) and McDonald’s (MCD).

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In consumer sentiment data, the latest reading of the Bloomberg Consumer Comfort Index declined to -29.

"The latest results may mark the impact of challenges, including higher home-heating prices during the long winter, a sharp increase in food prices tied to California's drought and the rising price of gasoline," said Gary Langer, President of Langer Research Associates LLC, New York. Langer Research conducts the survey for Bloomberg.

"An increase or decrease in consumer sentiment would affect discretionary consumption expenditures," according to the report.

Consumer spending accounts for about two-thirds of the U.S. economy.

The relative weakness of retail and consumer discretionary stocks in 2014 is notable because the sector has handily beaten the S&P 500 in recent years.

Consumer Discretionary Select Sector SPDR ETF rallied more than 40% in 2013 and outperformed the S&P 500 in each of the last five calendar years.

Yet so far in 2014 the retail sector as a whole "has been underperforming the market for several months now as traders have shown favor to the lower-beta sectors like utilities and health care," notes technical analyst Andrew Thrasher.

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Looking at the consumer discretionary ETF, he says momentum, breadth and relative performance have continued to weaken this month. "Traders do not seem to be showing signs of bullishness for this sector and with the latest price action, it doesn't seem the mood is shifting anytime soon," Thrasher concluded.

Meanwhile, Utilities Select Sector SPDR Fund (XLU) is the best-performing sector so far this year with a total return of more than 8%. Utilities are a traditional defensive sector that investors favor during times of heightened uncertainty in the market.

Also, the outperformance of Consumer Discretionary Select Sector SPDR ETF versus Select Sector SPDR Consumer Staples ETF (XLP) is another sign of a defensive sector rotation in stocks. When discretionary is lagging staples, "it tends to be a contractionary signal for the equity markets," writes Charlie Bilello at TheStreet.

Learn more about sector rotation portfolios on the Covestor investing marketplace.

Photo Credit: ehoyer

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.

Matthew Pierce

Matthew Pierce

Island Light Capital Corporation is an investment advisory and consulting firm that specializes in the development of optimally diversified investment

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