The stock market seems convinced the Federal Reserve is close to pausing its interest rate increases, and if that is correct, consumer discretionary stocks should have more runway.
The S&P 500 has risen almost 17% from the low point of its bear market in early October. Part of that gain came Wednesday, when the central bank voted to lift interest rates by another quarter of a percentage point.
And while Fed Chairman Jerome Powell said more hikes could be coming, he added the Fed will rely on economic data when it makes its decision—and with the rate of inflation in decline that gave the market reason to believe the hikes are almost over.
Higher rates are meant to cool inflation by reducing economic demand, so the end of rate hikes signals a bottom in economic growth. That economic relief would enable households to spend more money—and that has been reflected in consumer discretionary stocks.
The Invesco S&P 500 Equal Weight Consumer Discretionary Exchange Traded Fund (ticker: RCD)—which weights each stock in the sector equally and therefore strips out the outsized impact of
(AMZN)—has gained about 27% since the broader market began falling in October. The fund owns companies in retail, restaurants, travel, and other industries that benefit most when consumers have more money to spend.
So if the broader market has any more rallying left in it once a Fed pause commences, consumer discretionary stocks would likely benefit. Evercore strategists upgraded the consumer discretionary sector to Outperform Wednesday.
“Consumer Discretionary has once again taken up its traditional ‘worst to first’ role,” said Evercore strategist Julian Emanuel. That means the sector was one of the first to underperform the market when it tanked in early 2022 as the Fed started hiking rates, and is now first to outperform as the outlook brightens.
(RL) is a good example. A member of the consumer ETF, the stock is up about 38% since the start of the market rally, so it could keep outperforming for some time if the market’s thesis on the Fed remains intact. To be sure, analysts have cut their earnings estimates by a few percentage points in the past few months according to FactSet, and management has called out a weak consumer in Europe as a challenge to sales. And while the stock looks more expensive on a price-to-forward earnings basis, it could still have more room to run. It might have to rally and then flatline—or drop—but if the profit outlook improves from here, the stock could then resume its rise over the longer-term.
(POOL), distributor of swimming pool and related products, is another one. It, too, is in the fund and has rallied about 33% during the market’s run. That is a good sign for the near-term, though it has a similar caveat. Analysts have lowered 2023 earnings per share expectations by almost 20% since the start of October, so with the stock up, it has gotten more expensive. It trades at almost 24 times forward EPS, roughly 30% above the S&P 500’s aggregate P/E multiple. The stock traded at a mere 12% premium at the start of the rally.
The key for traders: more gains in the short-term could be in store. Don’t be surprised to see some weakness, but a brightening consumer outlook should keep the stocks moving higher over a longer period of time.
Write to Jacob Sonenshine at firstname.lastname@example.org