As hard as it is to say, I’m still bullish on the consumer.
It feels so wrong, which is what makes it so right from my unique approach to tracking the market (more on that in a bit).
For more than a year, analysts and the media have cast doubts all over the consumer’s ability to handle inflation and a weakening economy.
Despite the doom and gloom stories about our economy, consumers keep swiping their credit cards and booking vacations. That’s resulted in one heck of a bullish contrarian trade that still has room to move higher.
I covered the Consumer Discretionary Select Sector SPDR Fund (XLY) just a few days ago along with a recommendation on how I’m trading the broader sector strength, you can read it here.
Now, it’s time to do a deep dive into the companies that are in the sector to identify a few trade opportunities.
Let’s start with a few details of the companies in the sector.
There are just over 50 stocks represented in the consumer discretionary sector.
The largest three: Amazon.com, Inc. (AMZN), Tesla Inc. (TSLA), and Home Depot Inc. (HD).
The smallest three: Mohawk Industries Inc. (MHK), Advanced Auto Parts, Inc. (AAP), and Newell Brands Inc. (NWL).
For the record, I’m currently bearish on NWL given its poor technical and fundamental standing. But we’re not here to talk about that. Let’s look at the bullish candidates.
The “dining out” experience has been one thing that has stayed consistent through the surge in inflation.
For the last year, we’ve seen patrons continue to flood into fast-casual and mid-market restaurants.
It was simple math for a while – restaurants weren’t raising their prices as quickly as grocery stores. This meant that patrons could eat out for less than they would spend cooking at home.
Those times have changed as restaurants have updated menus to reflect their pricing. Nonetheless, the consumer has still been fine with spending a little more for the convenience of dining out.
One company continues to lead the consumer discretionary sector in this category: Chipotle Mexican Grill, Inc. (CMG).
Shares of Chipotle are 51% higher year-to-date as the company has been one of the top 10 performing stocks among the group.
The strong technical performance comes from a surge in the company’s fundamental performance.
The last two quarters have displayed Chipotle’s ability to maintain its market dominance in its space by passing higher prices to its guests.
They’ve done that without backlash from their guests too – maybe charging extra for guac is actually a strategic play from the start.
This has helped the company to maintain its operating margin performance. A feat that other companies in all sectors have struggled to achieve.
I’m telling you things that you could look up yourself so far. Let’s get into my unique look at the stock.
First, the price activity in Chipotle has a familiar signature that suggests shares are ready to surge higher.
Since reporting its quarterly earnings in April, the stock has been relatively quiet, and range bound. That’s about to change.
The stock is locked in what I call a “volatility squeeze”.
This situation happens when a stock trades more quietly than normal. Call it the “quiet before the storm”. Because in almost all cases, quiet stocks like Chipotle come out of their hibernation and start making swift and volatile moves.
The 50-day moving average (MA50) for Chipotle’s shares is in a strong uptrend and just provided support for the stock.
This is nudging shares higher above their top Bollinger Band, which will be the catalyst for the next surge higher for the stock’s price.
Here’s the chart:
The green arrow identifies the current price movement as it breaks its volatility silence.
In addition to the volatility pushing shares higher, we’re likely to see investors and traders start buying the stock again.
Chipotle’s earnings are in just under a month. Investors are likely to start “buying the rumor” as we get closer to that earnings date of July 26, 2023.
Buy the rumor rallies occur more often on stocks that beat their previous quarter’s earnings targets. The previous quarter’s beat sets the stage for investors to have a “fear of missing out” on the next earnings jump.
Another “Behavioral” catalyst for higher prices over the next few months lies in the hands of the analysts tracking Chipotle shares.
Right now, the average target price of the 25 Wall Street analysts tracking the stock is $2,050. That target price is below current share prices. This means that the analysts are likely to start issuing target price upgrades.
Target price upgrades are great for prices as the raised price targets are bullish for a stock. Earlier this week Wedbush Securities raised their price target to $2,300. If history is an indication, we will see more analysts do the same as the next earnings announcement approaches.
So, where do the shares go from here?
My intermediate-term target for the stock is $2,400 which represents a 13% move higher for Chipotle shares.
There are two ways to trade this stock from here.
First, keep it simple by purchasing shares of Chipotle (CMG). I’ve added the stock to my long-term stock portfolio based on my outlook.
The second is to bring the cost down and leverage the expected move with options.
At more than $2,000 options on Chipotle are more expensive than options on Microsoft. That goes without saying. But, given the stock’s outlook, I’m still a fan of this approach though it may cost a little more.
Here’s an option that I am considering using for the upcoming rally.
The August 18, 2023, CMG $2,150 calls should be trading for a price of around $7,800 per contract. This option would provide the opportunity to leverage the expected move in shares of Chipotle.
Should the shares hit my target of $2,400 the option would more than double the intrinsic value of the option alone.
Options traders that want to reduce the cost even further could execute a vertical call spread strategy by selling a further out-of-the-money option.
We’ll talk about this strategy in more detail in the weeks coming.
June 29 2023