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For all the talk about the stock market being disconnected from the economy, there is little mention of how disconnected the consumer discretionary sector is from the consumer.

Since the market bottomed on March 23, the S&P 500 consumer discretionary sector has jumped 76%, making it the best performer in the index over that time period (even slightly outperforming tech, which is 73% higher). At the same time, unemployment jumped to a never-before-seen rate, and consumer confidence has begun to wane.

The future of this sector, like many others, hinges on the rebuilding of the job market, the reopening of the economy, and a steadily improving economic outlook. That may sound like a tall order, but the consumer might be in better shape than you’d expect. And if you believe the consumer can weather the storm until a vaccine and government stimulus arrive, there may still be pockets of opportunity within the high-flying sector.

Disconnect Similarities to Tech

As the consumer discretionary sector was soaring to new highs off its pandemic lows, the unemployment rate spiked to 14.7% in April and as of July stood at 10.2%, higher than the 9.9% peak of the Great Financial Crisis. Over 27 million people are currently collecting unemployment, and in the past two months, consumer confidence has slid. The broad sector that is made up of restaurants, retail stores, cruise lines, auto manufacturers, home builders, casinos, and apparel manufacturers has nonetheless continued to thrive, despite sour news from Main Street.

Or at least it seems that way on the surface.

The reality is that only 39% of stocks in the sector are in the green, or have positive returns, for the year-to-date period. That means the consumer discretionary sector performance, like the S&P 500, is being supported by a smaller group of stocks.

You may have forgot, but Amazon is included in the discretionary sector, and given its market cap, it has played a big role in the sector’s outperformance. It represents a whopping 46% of the market capitalization of the sector. Because the S&P 500 index and its sectors’ performance are calculated based on the market cap weight of each security in the index or sector, securities with a greater weight contribute more to performance. The five largest consumer discretionary stocks are Amazon, Home Depot (8.5% market cap), Nike (4.7% market cap), McDonald’s (4.3% market cap), and Lowe’s (3.5% market cap), making up 67% of the sector. All five stocks are higher year-to-date, as they are among the industries that consumers have flocked to during the recession. Still, Amazon’s 86% pop year-to-date is the top driver of sector action.

Smaller but Still Adding Value

Don’t get the message wrong. Even with the biggest stocks driving discretionary sector performance, the smaller companies that make up the rest of sector have joined the rally off the bottom, with nearly 70% of them at least 55% higher since March 23. For consumer discretionary to stay ahead of the pack, more of these stocks will need to turn green for the year.

Chart depicting S&P 500 consumer discretionary top performers since March 23, 2020. Market cap of top 10 performing stocks: 3.8%. The lowest year-to-date performance is the consumer discretionary sector at 76%, followed by CarMax (123%), LKQ Corporation (128%), Royal Caribbean (136%), D.R. Horton (145%), MGM Resorts (149%), PulteGroupe (158%), Lennar (158%), The Gap (177%), Whirpool (177%), L Brands (226%).

Consumer Strength Improving

While there is still uncertainty about the next wave of stimulus and the trajectory of the job market, some data suggests the health of the consumer has improved in the past couple months. Spending rebounded strongly in May through July, after sharp declines in March and April. That has been reflected in retail sales, which reached a new record high in July. The average year-over-year growth in personal income over the past four months has neared double digits, due in part to the stimulus checks and enhanced unemployment benefits. Those benefits have since disappeared and may or may not return in the coming months, but the savings rate (18% in July) and increased level of deposits at banks suggest consumers have prepared for rainy days to persist. Consumer debt burdens have also been reduced for the first time since 2014.

Against that backdrop, a consumer that is still willing to spend on certain discretionary items has emerged. It isn’t just the largest companies that are benefiting, either. Retail has always been about getting the product right. Now is no different, companies that offer the consumer what they want, where they want (and feel safe), have benefited. So have their stocks.

Opportunity Within Discretionary

There is no doubt the unemployment situation is the worst we have seen in our lifetime. In the moment, market action feels unfair, but the market acts as a forward-looking mechanism and does its best to price in the future state of corporate earnings and thus, the economy. When you step back and look at the bigger picture of 1) consumer economic data improving, 2) earnings projected to get better in the quarters ahead, and 3) the consumer seemingly prepared to wait out a stalemate in Congress and the development of a vaccine, there could be opportunities for patient investors in several consumer discretionary stocks that remain below pre-COVID highs.

The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.

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Headshot of Lindsey BellLindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.