Are Consumer Stocks Signalling a Market Top?

The US stock market closed on a high last Friday with the Dow Jones Industrial Average over 27,000, and the S&P 500 Index over 3,000 after testimony before Congress from US Federal Reserve (the Fed) Chairman Powell confirmed market expectations that the central bank will likely lower borrowing rates at the end of July. The rate cut expectation comes despite strong reported US job-growth and stable consumer inflation, factors some analysts and economist point to as reasons not to lower borrowing costs. Analysts are increasingly concerned that the Fed may be giving into political pressure from the White House and stoking the market in a way that may not end well.

Expected interest rate cuts mean pro-cyclical stocks continue to be in vogue this year and one sector that has benefited the most are consumer discretionary stocks. For example, the Consumer Discretionary Select Sector SPDR ETF (AMEX: XLY) is up 26.18% in 2019, which is 5.96% better than the broader market SPDR S&P 500 ETF (AMEX: SPY) as of Friday’s close on 12 July. The only other S&P 500 sector to perform better than consumer discretionary is technology, up 31.8% in 2019.

Top Three Consumer Discretionary Stocks

Three of the highest weighted consumer discretionary stocks in the XLY are Amazon.com Inc. (NASDAQ: AMZN), Home Depot Inc. (NYSE: HD) and McDonald’s Corporation (NYSE: MCD). Analysts differ on how to categorise these stocks correctly. For example, Amazon is the largest of the 66 stocks in XLY consumer discretionary ETF with a weighting of 23.67%, but Finscreener.com reports the stock as a Services / Catalog & Mail Order company.

Amazon.com reports 2Q19 earnings on July 25th and analysts expect the company to deliver earnings per share (EPS) of $5.28, which is down 14.7% compared to 90-days ago. Amazon may still surprise to the upside, however. Last quarter’s EPS was 53.8% better than analysts had forecast.

Home Depot (10.27% weighting in XLY) reports 2Q19 numbers on August 13th and analysts are looking for EPS of $3.09, which is down nearly 1% compared to 90-days ago but still a respectable figure. The company beat analysts 1Q19 EPS forecasts by 4.61% with a reported earnings figure of $2.27 per share, and the stock price is up 27% so far in 2019.

McDonald's (7.13% weighting in XLY) reports 2Q19 numbers on July 26th and analysts are looking for EPS of $2.06, which is also down nearly 1% compared to 90-days ago. The company missed analysts 1Q19 EPS forecasts by 0.58% with a reported earnings figure of $1.72 per share, but the stock price is up 20% so far in 2019.

Bottom Line

Investors have reason to be concerned the Fed will take things too far and cut rates when it is not required. Doing so tends to push asset prices ever higher in a fashion that may be inconstant with companies’ fundamental financial performance. One of the sectors to benefit the most this year has been consumer discretionary stocks. Investors should carefully watch the 2Q earnings releases from Amazon, Home Depot and McDonald's to anticipate what might happen to stock prices. If these names beat analysts’ expectations, then the current rally may be sound. If these stocks miss Wall Street expectations, then the current stock rally may be running on fumes.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.