• Consumer discretionary stocks are outperforming consumer staples in a risk signal for the broader market.

• Gains in the consumer discretionary sector reflect a strong economy and high consumer confidence.

• The S&P 500 correlates strongly with discretionary spending during bull market moves.

The stock market is showing an under-the-radar bullish signal that suggests the ongoing recovery will extend into 2025.

The signal is simple, but powerful: the outperformance of risk stocks relative to defensive stocks has reached all-time highs.

Specifically, consumer discretionary stocks have hit new highs when compared to consumer staples stocks.

Consumer discretionary stocks are considered risky because they reflect non-essential spending, while consumer staple stocks satisfy consumer needs.

Consumers are thought to continue to buy products from companies in the consumer staples sector even when the economy is slowing or contracting. At the same time, they reign in their spending on discretionary items in times of economic hardship.

“Defensive stocks tend to lead when there’s trouble and we’re not seeing that,” Ryan Detrick, chief market strategist at Carson Group, told Business Insider. “That’s a good thing.”

Some of the leading companies in the consumer discretionary sector include Amazon, Tesla, Home Depoti McDonald’s. The main companies in the consumer staples sector are costco, Walmarti Procter & Gamblethat sells toilet paper, soap and diapers.

The widening yield gap indicates that investors are comfortable betting that consumers will continue to spend their incomes on goods they don’t necessarily need but want, given that the the economy remains strong.

The performance gap between the two sectors is staggering.

Year-to-date, the consumer discretionary sector is up nearly 3% compared to a 2% decline in the consumer staples sector.

And over the past year, consumer staples are up just 7% compared to a 34% increase in consumer discretionary. Outperformance also continues looking back three and five years. Meanwhile, the S&P 500 is up 2% from last year and up 27% from last year.

From a fundamental perspective, Arun Sundaram, senior equity analyst at CFRA Research, told Business Insider that a strong labor market has boosted consumer discretionary stocks. at the same time, concerns about GLP-1 weight loss drugs have exacerbated the fall in stocks of consumer staples.

“Investors are questioning the long-term impact of breakthrough weight-loss drugs like Ozempic on food and beverage companies, which dominate the consumer staples sector,” Sundaram said.

The story continues

But leaving aside what’s fundamentally driving the widening divergence in performance between the two sectors, this is typical investor behavior in a bull market, according to Sam Stovall, chief investment strategist at CFRA.

“Intuitively, it makes sense that when the consumer discretionary sector goes up, so does the S&P 500, as the consumer discretionary sector has a 93% correlation of monthly returns with the S&P 500,” Stovall told Business Insider.

By comparison, the consumer staples sector has a 73% correlation with the S&P 500, according to Stovall.

This is the type of behavior that investors want to see during bull markets, as it confirms the underlying trend that is driving stocks higher.

“When you look at sector returns during market advances and declines, consumer discretionary outperforms during advances and staples underperforms,” ​​Stovall said.

To account for the skewed weighting of Amazon and Tesla in the consumer discretionary sector, which together account for about 40% of the sector, Michael Batnick, director of research at Ritholtz Wealth Management, looked at the relative performance of consumer discretionary and consumer equally weighted. basic sectors

He likes what he sees.

“I’m not worried this sale at alland that’s the chart that’s giving me confidence,” Batnick said in a podcast this week for The Compound.

Batnick called it “the most bullish chart in the world,” adding that “this is not something you see in a bear market.”

Ryan Detrick, chief market strategist at Carson Group, told Business Insider that the risk signal isn’t limited to the relative performance of consumer discretionary products.

JC Parets, technical analyst and founder of All Star Charts, echoed the same sentiment when speaking with The compound and friends on Thursday

Parets provided a long-term chart of the relative performance between the two sectors, showing that the ratio’s chart has just broken above a key resistance level that was marked by the stock market’s peaks in 2007 and 2021.

Ultimately, this is a risk signal that suggests the stock market rally will continue.

“We’re not too worried that things will fall apart and the end is near as we keep hearing, as the right leadership is still in play,” said Carson Group’s Detrick.

Read the original article at Business Insider