Consumer Strength Signal Flashing Short-Term Caution Sign

Comparing the Consumer Discretionary Select Sector SPDR Fund (XLY) to the Consumer Staples Select Sector SPDR Fund (XLP) is a popular way to measure the strength of the consumer. The XLY is a consumer discretionary exchange-traded fund (ETF). Its two biggest holdings by far are Amazon.com (AMZN) and Tesla (TSLA), followed by Home Depot (HD) and Booking Holdings (BKNG), which provides online reservations for travel and restaurants. These companies will thrive only if consumers have enough to spend after their basic needs are met. The XLP is a consumer staples ETF whose biggest holdings are Walmart (WMT), Costco (COST), Procter & Gamble (PG), and Coca-Cola (KO). These companies provide basic groceries and everyday hygiene products, which are considered necessities.

The theory is the XLY will outperform if consumers have plenty of money left over after necessities. This has been the case over the past four months. The relative strength of the XLY to the XLP has spiked above 1.20, its biggest reading since the beginning of the year. The chart below shows just a few instances of similar spikes over the past 10 years. The market, according to this measure, is indicating healthy consumer strength. Next, I look at historical instances of pops in the XLY/XLP relative strength to see how stocks performed going forward.

When XLY Outperforms XLP 

I want to know if this spike in the consumer strength indicator has tended to lead to bullish stock returns. I went back to 1999, the first full year we have data on the two ETFs, and found times that the XLY/XLP four-month relative strength moved above 1.20. There have been 9 past occurrences. The table below summarizes the S&P 500 returns after them. The second table shows typical S&P 500 returns for comparison.

Stocks tend to do poorly in the short term. The S&P 500 averaged a loss of 0.82% over the next month, with just 33% of returns positive. Over the next three months, the index gained just 0.44% on average, with 44% of the returns positive. The typical three-month return for the index was 1.82% with 67% of returns positive. The longer-term returns look better than the short-term returns. The six- and 12-month average returns are close to the market average. 

Looking at the individual signals is interesting. The table below shows the dates of each signal and subsequent S&P 500 returns. There’s reason for optimism, as the first few signals were very bearish for stocks, especially in the long term. The recent signals have been much more bullish for the six and 12 month windows. The last five times this has signaled, the S&P 500 was positive every time over the next year, with a minimum return of 11.8% and an average of 26%. 

Above, we saw how the S&P 500 tended to perform after these XLY/XLP relative strength signals. The tables below summarize the returns of the two ETFs. The first table has the returns of the consumer discretionary ETF (XLY). The second table shows the consumer staples (XLP). You can’t make a strong conclusion with only nine data points, but based on the data below, the XLY (consumer discretionary) stocks have done better after these stocks than the XLP (consumer staples) stocks. The XLY has also outperformed the S&P 500 after these signals.