These consumer stocks are struggling. What it says about the market and U.S. households.

By Isabel Wang

Consumer-discretionary stocks hit lowest level relative to the S&P 500 since February 2013

U.S. stocks this week notched another round of all-time highs on the back of a surge from companies tightly linked to artificial-intelligence frenzy, but a look beneath the record-setting streak shows cracks are starting to form in some of the consumer stocks as American households pull back from their spending spree amid elevated inflation and higher interest rates.

Despite clinging to a roughly 1.4% gain so far this month, stocks with high exposure to non-essential goods and services have consistently trailed the broader market so far in 2024. The Consumer Discretionary Select Sector SPDR ETF XLY, off 0.2% year to date, was the second-worst performer among a set of funds that track each of the 11 S&P 500 SPX sectors this year, according to FactSet data.

And it has gotten even worse than that. Last week, over half the members of the consumer-discretionary sector traded below their 200-day moving average (MA), the highest percentage since November, according to Dow Jones Market Data.

The 200-day moving average is considered a key indicator by traders and technical market analysts for determining overall long-term market trends. When a stock price remains below its 200-day MA on the daily time frame, it is generally considered to be in an overall downtrend.

Also on Wednesday, XLY hit its lowest level relative to the SPDR S&P 500 ETF Trust SPY since February 2013, lagging behind the broader S&P 500 index, according to Dow Jones Market Data (see chart below).

"Consumers are feeling stretched," said Adam Phillips, director of portfolio strategy at EP Wealth Advisors. "If we see discretionary stocks doing well, also when the bond market is rising, we'd have more conviction in the stock market, but we're not seeing it right now, and that tells us maybe things are not as strong as they appear."

Years of persistent inflation and the Federal Reserve's monetary-tightening cycle have squeezed consumers who ran out of savings accumulated during the Covid-19 pandemic. Many households have to become more selective in the products they purchase and places they splurge.

The trend is consistent with disappointing economic data on consumer sentiment, wage growth, retail sales, the SM services sector activity index, and goods and services outlays. Delving into the core drivers of those indicators, one thing is clear: the overall condition of American consumers is weakening, analysts said.

Evidence of a consumer slowdown has also stacked up from companies within the consumer-discretionary sector who have reported quarterly earnings thus far.

Companies have cautioned that faltering spending has started to create a challenging economic environment where households become "discriminating" in how they spend their money, said Max Wasserman, co-founder and senior portfolio manager at Miramar Capital.

"They're much more cost-conscious, and that's affecting a lot of the [discretionary] stocks," he said.

Earnings from McDonald's Corp. and Starbucks Corp. saw consumers pull back on their food and drink expenses in the most-recent quarter due to elevated prices in their day-to-day spending. Shares of McDonald's (MCD) were down over 12% so far this year as lower-income consumers no longer spent their savings and turned to grocery stores instead of the fast-food chain, while Starbucks (SBUX) stock tumbled over 15% in the same period as foot traffic declined across its around 17,000 stores in the U.S..

Retailers, for their part, have cut prices and ramped up discounts to boost demand for discretionary goods, especially among lower and middle-income customers. Target Corp. (TGT) announced in late-May it was cutting prices on up to 5,000 items to lure back inflation-weary shoppers, with plans to lower prices for thousands more items over the course of the summer.

"It [the consumer slowdown] requires some of these consumer companies to rethink their value proposition, especially given the fact that they've raised their prices recently to offset inflation... so they're trying to find that equilibrium. But you are definitely seeing consumers trade down, specifically in the middle class," Wasserman told MarketWatch via phone on Wednesday.

See: 3 things to know before shopping the summer discounts at Target, Walmart, Amazon and more

The purchase of consumer-discretionary products is often compared with consumer staples, which have a higher level of necessity than discretionary items. Discretionary stocks are thus identified as cyclical as consumers tend to spend less during an economic slowdown or a recession, while staples stocks usually are more stable and may help to hedge portfolio risk.

The Consumer Staples Select Sector SPDR Fund XLP has gained 8.4% so far in 2024, according to FactSet data.

See: Target, Aldi cut prices on staples like chicken, diapers and pet food as shoppers rack up grocery debt

Matt Lloyd, chief investment strategist at Advisors Asset Management, said while the weakness in consumer spending reflects growing market concerns about high inflation and a slowdown in the economy, it doesn't necessarily indicate an imminent recession or "really bad times".

"It's pricing in a soft landing with a few headwinds," he told MarketWatch in a phone interview on Wednesday.

Wasserman said as long as the labor market remains relatively strong with a low unemployment rate, a slowdown in consumer spending doesn't imply that people stop spending - "they just spend differently and spend less," he said.

"If I still have $10, I'll spend it differently... instead of getting name brands, I'll go down to generics. However, the moment you take away my $10 because I lost a job, that's when you start seeing problems," he added.

U.S. stock indexes ended mostly flat SPX on Thursday after the European Central Bank cut rates for the first time in five years and as investors looked ahead to Friday's monthly jobs report.

See: May Jobs report could signal whether economy is weakening

-Isabel Wang

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06-06-24 1654ET

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