Why It’s Time to Sell These Consumer Stocks

Spending on travel is highly sensitive to shifts in the economy. Above, the Airbnb website. (Gabby Jones/Bloomberg)

Key Points

• Consumer discretionary stocks have risen 74% in three years, slightly less than the S&P 500’s 82% gain.
• A recent divergence between discretionary and retail funds, with retail falling since September, suggests a potential drop for discretionary stocks.
• Weakening employment and declining monthly restaurant spending since May indicate a potential slowdown in broad discretionary spending.

Consumer discretionary stocks have had a nice run. Selling is a sound idea now.

The stocks have taken off because sellers of nonessential goods and services do well when consumers have more money to spend. It made sense to buy the shares for a while because consumers have been getting hired and earning higher pay, and continue to do so. Expectations for interest-rate cuts by the Federal Reserve have helped as well, bolstering the expectation that profits at consumer discretionary companies will continue to increase.

The Consumer Discretionary Select Sector SPDR exchange-traded fund is up 74% in the past three years, just a few points below the S&P 500 ’s 82%. That isn’t bad, considering the S&P 500’s heavy weighting toward the Big Tech companies that are leading the charge in artificial intelligence.

Now, the fund looks to have risen so high that it could easily fall if consumer spending shows signs of weakening.

While it is usually trades more or less in line with the State Street SPDR S&P Retail ETF , according to research from Bear Traps Report, the two funds have recently diverged. The retail-only fund has fallen off a cliff since September.

That signals that unless companies in the broader discretionary fund continue to report earnings that are vastly better than those in the retail fund, the discretionary fund is likely to drop. Call it an example of “catching down.”

And there is plenty of reason to fear that broad discretionary spending will be disappointing. Monthly restaurant spending has been lower since May, according to the St. Louis Fed. And while travel spending is still growing, it is notoriously sensitive to shifts in the economy.

That matters, especially because the macroeconomic backdrop, most notably employment, is weakening. Though figures from the federal government aren’t available, private-sector data show companies are slowing down on hiring. This could force analysts to reduce their forecasts of sales and earnings for many discretionary companies, pressuring their stocks.

True, the Federal Reserve could respond to weakness in employment by cutting interest rates. That would support consumers’ spending power, but a December rate cut isn’t a certainty. “Far from it,” Fed Chair Jerome Powell told reporters after the bank’s most recent meeting on interest rates. Inflation remains above the Federal Reserve’s target, partly because of tariffs.

Investors who have owned consumer-discretionary for some time should consider the risks. Taking profits and reinvesting the cash makes sense.

Treasury bonds, yielding 3.5% to 4.7% depending on the maturity, are one safe option. Not only are those returns risk-free, they are above the rate of inflation.

Investors who want more stock market exposure, and larger potential gains than bonds can offer, can buy less risky stocks. One option is consumer staples, a category that has underperformed the market and is trading more cheaply now. Barron’s recently recommended select staples stocks that are growing and have earned increased forecasts of their profits from analysts.

It’s up to investors’ discretion: Bet on safety, or on more gains in travel and restaurant stocks.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com