“Don’t Count the Consumer Out Just Yet”

There are certain tenets of the economy and the market that you learn and respect.  One of those is that the consumer controls the economy, and therefore the market.

That belief is based on the fact that consumer spending accounts for more than 70% of the economy.  Healthy consumers, healthy economy.

Here’s where it gets interesting…

The consumer should be worried right now, but they aren’t.

Just a few weeks ago, CNBC’s “Millionaire Survey” showed that the “rich” are cutting back on their spending.

Fewer trips, less dining out, and drinking cheaper wine are the type of adjustments that are being made in the top income groups.  The reason?  The same that we’re all worried about.  Higher inflation and the economy.  In addition, the “rich” are hoarding cash.

They expect that things are going to get worse, not better.  

They believe Inflation will be tough to tamp down to 2%.  

They also believe that interest rates will continue to be higher.  

Not so coincidentally, these are the same things that Jerome Powell just confirmed last week.

Despite the dour outlook and actions of the rest, the rest of the consumer economy is happy to keep spending.

And that’s creating a short-term profit opportunity that I’ll be giving you at the end of this article.

But first, let’s take a look at the facts

The Consumer Discretionary Select Sector SPDR Fund (XLY) is up 30% year-to-date.  

The sector is comprised of companies like Nike Inc. (NKE), Delta Air Lines, Inc. (DAL), Amazon.com, Inc. (AMZN), and Home Depot Inc (HD) just to name a few.

These stocks are at the heart of consumer spending.  And despite the actions of the “rich”, these stocks continue to fly.

The reason is somewhat simple.  Consumer discretionary stocks are climbing the “Wall of Worry”.

I talked about the benefits of my Behavioral Trading perspective with the homebuilding sector last week.  The same catalysts are in place for the consumer discretionary sector, telling me that the rally still has legs. 

Here’s the setup.

Fundamentals: Poor

This is the one leg of the trade that is the weakest.  But it’s still supportive.

After a rough earnings season, we saw many signs that consumer retail activity was slowing.  Even this week we’ve seen Walgreens Boot Alliance Inc (WBA) plummet due to weaker expectations.  

I actually just posted a video on our YouTube Channel breaking down this exact stock – check it out

Despite that view from the consumer companies, there is data telling us that the consumer keeps spending.

Housing starts and home sales are bullish.  That’s one of the strongest contributors to continued spending.

Consumer Confidence for June came in much better than expected on Tuesday.  That’s another bullish driver.

Data from some of the larger credit card issuers show that consumers are still actively utilizing their credit cards for purchases.

The summary, consumer discretionary companies are expecting a slowdown, it’s just not happening yet.

Investor Sentiment: Pessimistic

Like homebuilding stocks, investor sentiment towards consumer discretionary stocks is bearish.  

This sets the stage for the continuation of a contrarian trade higher.

The media has been calling for the top in consumer stocks for the last six months, despite the rally higher.  This is one of the classic signs that a sector is in a sustainable trend.

Short sellers are also trying to call a top in the consumer discretionary stocks.  

There have been some large increases in short interest in the consumer discretionary sector.  Elevated short interest indicates that short sellers are trying to call a top in these stocks.  

This activity sets the stage for a short squeeze in the sector, which will result in even higher prices.

The Technical Picture: Bullish

XLY is firmly trading in a bullish trend as indicated by the rising 50-day moving average (MA50):

The last week has seen some consolidation sideways after the XLY’s Relative Strength Index hit levels indicating an overbought situation.  We may see a little more selling over the next few days, but that would still be considered part of a “healthy consolidation” that would represent a short-term pause that gives the bulls a chance to rest.

I’m specifically watching for XLY to break back above the $167.50 level as a sign that the shares are ready to charge to the next target.

My review of the longer-term chart suggests a target price of $180 after breaking above $167.50.  That’s a 9% return from current prices.

Let’s Trade it

Just like yesterday’s look at the Regional Banks, I prefer to take a position in the XLY.  More specifically, I’m considering the August 18, 2023 XLY $167 Calls which are currently trading at $5.60 per contract.  My target selling price for these calls will be $8.25, a 50% gain.


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