Posted by Jeffrey Buchbinder, CFA, Equity Strategist
Wednesday, May 25, 2022
While the S&P 500 Index has not yet fallen into bear market territory (a decline of more than 20% based on closing prices), there are a number of areas of the market that have already endured bear market declines. The technology-heavy Nasdaq is already there, with its near-30% decline since November 19, 2021. The average S&P 500 stock is down about 24% from the highs. The small cap Russell 2000 Index has fallen 28% since its record high back on November 8, 2021.
“While the S&P 500 Index has not officially entered bear market territory, plenty of areas of the market have,” noted LPL Equity Strategist Jeffrey Buchbinder. “The consumer discretionary sector is one of them with a 35% drop from its November 2021 high. And as we heard from some of the biggest retailers during earnings season, the outlook is only getting tougher as energy prices soar and supply chain problems persist.”
The LPL Chart of the Day illustrates just how difficult earnings season was for the consumer discretionary sector. No sector saw its earnings estimates for the next four quarters cut more during reporting season than consumer discretionary. Retailers have struggled with the transition from pandemic to reopening and intensifying cost pressures. The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) maintains its negative view of the sector.
The impact of inflation and snarled supply chains on retailers, the biggest piece of the discretionary sector, is widely understood. But we would argue that it’s not quite priced in.
The next chart shows the price-to-earnings ratio (P/E) for the discretionary sector relative to that of the S&P 500 Index. The sector still trades at a 34% premium to the market, compared to the 10-year average of 26%. That’s certainly a lot more reasonable than the 100% premium valuation the sector reached last summer, but we would argue that the sector still does not warrant valuation support. This market has not been friendly to richly valued stocks, and consumer discretionary still has a good amount of them despite the more than 30% decline.
From a technical standpoint, our analysis doesn’t get any more optimistic. The sector was one of the top performers off the market low, outperforming the S&P 500 by more than 10% in the first year following the COVID-19 driven bear market. However, since then relative performance has significantly deteriorated and the sector now sits at its lowest level relative to the S&P 500 since January 2015. And while the sector is one of the most concentrated, with biggest components Amazon and Tesla accounting for an eye-popping 46% of the sector, the weakness has been broad based as only 2 of the 60 stocks in the index remain above their respective 200-day moving averages.
The sector has a lot going against it right now but there is a silver lining. The hotels, restaurants, and other travel & leisure categories are getting a boost from the reopening. It hasn’t been enough to offset the other headwinds mentioned above, but once the the inflation and supply chain headwinds ease further, the sector could be poised to rebound. The potential for interest rate stability should eventually help higher priced growth stocks like those that make up the bulk of consumer discretationary sector. It’s just too early in our view.
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