The stock market roller coaster has continued this week, with the market moving well in excess of 300 points on the Dow every single day. This kind of volatility is enough to make investors dizzy. It also will likely provide reason for increased caution from investors. This doesn’t necessarily mean a down market, but certainly one where the less risky stocks should garner more interest.
The swings in the market are very much driven by our fearless leader’s penchant for tweeting. In particular, his trade-related attacks on China have driven the recent market swings. But, looking beyond this, there are several other global-macro driven phenomena occurring that are likely to have an equal if not greater impact on investors than a potential trade war.
In this week’s newsletter we will examine a few trends that are happening right now, and explain why they are leading to a conclusion that, perhaps, the best place to be putting your equity dollars to work is in the consumer sector.
During a down market, Consumer stocks have outperformed…
I have thought for a while that we would be in a volatile, sideways market. That has been the case this year. The fundamental strength in the economy, combined with strong earnings, provides solid underpinnings for the market. The fact that we’ve been in an extended bull market (especially for large caps and FAANGs), means the market is not cheap and is due for a pullback.
Looking at the 6 month chart, it appears my sideways market call is likely to be tested…on the downside.
Let’s assume that we are in the beginnings of a bear market. However, not a brutal, bubble-imploding crash, as I don’t see any bubbles out there (with the possible exception of the very long bull market in bonds…). How do different sectors perform during these times historically.
Recently, we have two examples. First, when the S&P slumped 7.4% from the close on Sept. 18 through Oct. 14, 2014:
And, secondly a bigger drop from July 22 through Oct. 3, 2011, when the index fell 18.3%:
As you can see, during both these downturns, consumer staples were the second best (or least worst) performing group. During a down market, these seem to be the stocks to hang out in.
Trade wars, increasing wages, could spark inflation…
With our president looking to impost significant tariffs on imports, we have the potential for a very inflationary period. Now, we all know these tariffs may never happen. But, even if they don’t come to fruition, we are in a period of record low unemployment and what looks to be the start of wage inflation.
The CPI index is starting to reflect the return of inflation. Forecasts are for it to increase, see below.
If a trade war occurs, or wages start to increase rapidly, we could see an acceleration in the rate of increase in CPI. This would be a boon for consumer staples such as P&G and Colgate.
Large consumer companies like these have the ability to raise prices with inflation, so their margins might not increase, but their net profit should benefit. And, wage inflation plays right into their hands as that directly results in more consumer spending.
As City A.M. said recently:
I concur that, in the current environment, consumer stocks will benefit from inflation. However, if these trade wars never really happen, they could lead to improved trade agreements. This is what Trump intends (a more level playing field), and that would be a huge bonus for consumer stocks as you’d see China start allowing them more opportunities to access that market.
The weaker US Dollar benefits international companies, like large consumer staples companies.
It has been my contention for well over a year that the US Dollar is going lower. During that time, here’s what’s happened.
It has held up recently, on the flight to quality, but I believe we can expect the downtrend to resume shortly. A trade war will certainly not help the dollar and, at the same time, we are seeing foreign countries start to catch up to us on raising interest rates.
A weaker dollar is a boon to international companies as their foreign earnings are translated back into USD.
Consumer stocks have underperformed lately…time to revert to mean.
Over the last year, consumer stocks have dramatically underperformed the market. This is not a surprise when the leaders are FAANG stocks, which are all tech names.
But, the leadership is changing. Whether the market sells off, or rallies, I believe we are entering a period where the FAANG stocks will not be leading the market. They are over-owned, have outperformed dramatically, and are due for a rest.
Meanwhile, everything seems to be setting up for a period of catch-up from the consumer sector. Time to buy some of them.
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