The dramatic capitulation discussed in early May helped to provide some much-needed relief for Consumer Staples, unfortunately the ensuing bounce did little to heal the structural damage that had been inflicted. Now overbought with substantial resistance overheard, for those tactically inclined, harvesting some of these recent gains seems like a prudent strategy.
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In what has steadily become a more risk averse environment for equities, it is what many consider a “defensive” sector that is leading the market to the downside this year. Trailing the S&P 500 by nearly 1100 basis points YTD, Consumer Staples possess some of the weakest trends and downside momentum in the market today. Relative performance has been in freefall for the better part of the past two years, reaching levels last seen in ’07. The selloff since January’s peak has been swift and painful – slicing through support and calling into question longer-term trends. However, internals are signaling that some relief is in order as 52-week lows swell to their second highest level since ’09. The sector is far from leadership and while I am hesitant to aggressively step into this oversold condition, the contrarian in me is intrigued by this blow off in internals coupled with the weakest relative performance since right before the last bear market.
The beauty of equal weight indices is that they give you a true sense of the participation and breadth behind a market or sector move. I mention this because I’ve received a fair number of questions around what seems to be a bullish acceleration in the relative performance of discretionary, helping to reverse what had been a two-year downtrend. Up a touch over 7% year to date, Discretionary is nicely ahead of the S&P 1500’s 4% return and is the market’s second best performer behind technology. I hate to throw cold water on what seems to be a solid start to the year, but these results are great influenced by two of the hottest stocks in the market today – Amazon (AMZN) and Netflix (NFLX). These two names account for almost a quarter of the sector’s capitalization and are up 37% and 68% respectively YTD. However, the remaining 246 constituents have posted meager results with a median decline of 0.6%.
In a market of extremes, discretionary’s outperformance over Staples stands out as well. This is definitely a tricky one as trends continue to heavily favor discretionary, but one has to question whether the vertical acceleration experienced over the past few months is sustainable and not prone to some mean reversion. Retail has been discretionary’s biggest winner of late, disposing of last month’s overbought condition with ease. For the bulls, now the hard work begins, as the latest overbought environment is developing at crucial multi-year resistance. The group’s ability to successfully navigate this important level will go a long way to easing our longer term trend concerns.
Internally oversold entering its seasonally sweet spot has helped to create the perfect elixir for the long suffering retail industry. We were looking for a solid counter-trend move (Link), but admittedly have been surprised by its magnitude and breadth. That said, as seasonal tailwinds soon become headwinds, the group is facing its deepest overbought condition since this time last year, a setup which quickly resolved itself to the downside. We might be a bit premature, but I’m comfortable opening this gift a few weeks early.
Our view on staples can be summarized pretty succinctly - rich multiples, lackluster growth and challenging technicals. Not an ideal combination. However, it is a relative world, which shines a positive light on select beverages such as KO, BF/B, STZ and SAM. Despite its leadership status and limited breadth, the industry continues to offer a fair amount of relative shorts as well (e.g. PEP, DPS), helping to provide what is developing to be an interesting pair trade – Long KO/Short PEP. As the chart below highlights, KO is consolidating at $47 resistance, but looks poised to take this level out, while PEP is struggling to create any sense of upward momentum at support. The relative performance of KO vs. PEP is breaking out, and looks like it has some room to run.
While not a surprise given the healthy risk appetite among investors, the Discretionary sector continues to outpace Staples, highlighted by the recent acceleration through formidable resistance to fresh highs (chart below). While we have seen a very slight improvement in Discretionary over the past month, this is more a function of the troubles that continue to plague Staples from both an absolute and relative perspective.
With both the discretionary and staples sectors trading at fresh relative lows, we have seen little materialize in the charts that would alter our underweight view for each. While it's clear that challenges persist for both, long and short opportunities continue to emerge. On the long side, Polaris and PVH continue to intrigue us, while Coach faces an important oversold condition following its recent gap lower within a larger base formation. Homebuilders are slicing through their absolute and relative uptrend for the first time in nearly a year, creating interesting oversold conditions in KBH, LEN, TOL and MTH as each wrestles with its respective 200-day. On the flip side, 2 longer-term uptrends are being called into question, where Domino's and Mondelez are displaying the distributive price action that should warrant some caution.
Of all the sectors we have written about over the past few weeks, Consumer Staples has been the biggest challenge. Not from a trend perspective, as relative performance remains in a well defined downtrend, but from an excitement standpoint. Outside of Constellation Brands bullish gap yesterday post-earnings, there just aren’t a lot of actionable ideas on the longside. It’s gotta be a sign, right? The sector tends to do well when risk-aversion creeps in, and given our near-term reservations around equities, the chart below grabbed our attention. Admittedly not a game changer, but from a seasonal perspective relative performance tends to drift higher throughout the 3rd quarter, which ties in quite nicely with our expectation for increased volatility in the months ahead. As the sector once again flirts with long-term support on a relative basis, every little bit helps.
Led by the difficulties within retail, Consumer Discretionary sector remains one of the more treacherous sectors to navigate. The long awaited improvement in relative performance has stalled out once again, as the recent overbought condition came into play at downtrend resistance. Many of the relative issues can be traced back to retail, but media and autos are clearly not helping. On the flip side, there are a number of industries exhibiting bullish price action and trends, with Diversified Consumer Services, Hotels, Restaurants, Household Durables and Internet leading the way. Speaking of Internet, we have received a fair number of questions on whether F.A.N.G. and its two consumer members are buyable on their most recent pullback.. Our sense is that a deeper oversold condition will develop during the 3rd quarter, but as the chart below highlights, AMZN looks to be basing on a relative basis versus NFLX. We ran a similar exercise for GM & F and PHM & CAA in today’s report (6/29/17), along with a look at a handful of names that caught our eye on a multi-year basis.
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