Uptick in Consumer Spending Could Mean a Second-Half Market Rally

NEW YORK (TheStreet) -- The exchange-traded fund representing companies sensitive to economic cycles is doing far better than the ETF of companies selling food and other necessities consumers need. That could mean better times in this back half of the year for the economy and the stock market as consumer sentiment improves.

The Consumer Discretionary Select Sector SPDR (XLY) includes Walt Disney Co (DIS), Amazon (AMZN), Home Depot (HD), McDonald's (MCD), Ford Motor (F) and Starbucks (SBUX). It is currently trading around $67, down a fraction for the year to date.

By contrast, the Consumer Staples Select Sector SPDR (XLP) includes Procter & Gamble (PG), Coca-Cola (KO), Philip Morris International (PM), Wal-Mart Stores  (WMT), and CVS Caremark (CVS). that ETF trades at $44, up 2.8% for the year to date.

Until recently, spending was tight. But consider the chart below.

XLY Chart
XLY data by YCharts

Looking at the relative strength of a basket of consumer discretionary stocks over a basket of consumer staples stocks is an important determinant of consumer behavior as discretionary spending predicts future economic growth.

Consumer spending accounts for up to 70% of economic activity, so essentially the more they spend the faster the U.S. economy grows. Similarly, discretionary spending is more elastic than spending in the consumer staples space. For example, a person may not need a new rake from Home Depot if money is tight, but will always need to get their medications at the local CVS.

Earlier this year, discretionary stocks took a massive nose-dive compared to consumer staples. Weak employment growth and severe winter weather in the first quarter deterred people from shopping and led investors to sell discretionary names across the board.

Recently, however, discretionary stocks have begun to show some strength again. This is a positive sign as stronger spending from the consumer indicates sentiment is on the rise, and economic growth could accelerate in the second half of the year.

Over the past three years, when discretionary stocks pivoted from lagging to leading the staples sector, it incited a strong rally in the SPDR S&P 500 (SPY).

SPY Chart
SPY data by YCharts

This week is also important for the consumer discretionary sector as both July Retail Sales and August Consumer Sentiment figures are released. Retail sales are expected to show improvement on June’s mild 0.2% gain.

Andrew Grantham, an economist at CIBC World Markets, expects to see spending increase gradually in the second half of 2014 and then accelerate in 2015, according to an investor note. “There are growing indications people are willing to take on more credit and spend more,” he said.

If the economy continues to add jobs and part-time labor declines as a percentage of the workforce, then wages should eventually rise over the next few years. This will lead to more disposable income for the consumer, which should translate into continued leadership of consumer discretionary stocks over the more inelastic consumer staples sector.

A way for the investor to get exposure to stronger consumer spending would be to look for recently battered companies that show signs of bottoming.

Dan Wantrobski, managing director of Janney.com, said in a research report that investors looking to gain exposure to consumer spending “may find opportunity” in some of the flushed-out shares of companies in the apparel group.

Among some stocks he recommends considering, Urban Outfitters (URBN), Abercrombie & Fitch (ANF), and American Eagle (AEO), which all “show promise” he states.

URBN Chart
URBN data by YCharts

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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