Key Consumer Strength Indicator Investors Should Watch

The relative strength of the XLY to the XLP has hit its highest level since mid-2020

Senior Quantitative Analyst
Aug 17, 2022 at 8:00 AM
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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 ETF. Its two biggest holdings by far are Amazon (AMZN) and Tesla (TSLA) followed by Home Depot (HD), McDonald’s (MCD) then Nike (NKE). These companies will do well only if consumers have enough to spend after their basic needs are met. The XLP is a consumer staples ETF whose biggest holdings are Procter & Gamble (PG), Coke (KO), Pepsi (PEP), Costco (COST) and Walmart (WMT). These companies provide everyday hygiene products and food 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 two months. The relative strength of the XLY to the XLP has spiked to its highest level since the early stages of the Covid recovery in mid-2020. 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.

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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 2000 and found times that the XLY/XLP 2-month relative strength moved above 1.10 for the first time in at least 90 days. There have been 17 past occurrences. The table below summarizes the S&P 500 Index (SPX) returns after these instances. The second table shows typical S&P 500 returns for comparison.

Stocks tended to do well over the next month averaging a 1.8% return with 71% of the returns positive. The typical return for the index was 0.51% and 63% positive. The three- and six-month returns aren’t as bullish showing a lower percent positive than your typical market. Then you see a strong average return over the longer term, one year. The S&P 500 averaged a gain of over 11% a year after a signal compared to a typical return of 6.8%.

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Historically, the S&P 500 tends to be bullish after these signals. The tables below indicate the types of stocks we want to be in. I’m comparing the returns of the two ETFs after these 17 prior signals. The first table summarizes the returns of the consumer discretionary ETF (XLY). The second table shows the consumer staples (XLP) returns. The consumer discretionary stocks easily outperformed the consumer staples in these circumstances. This was predictable given the strength of the market in general as we saw above. The XLY is typically a better play when the market is strong.

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