Consumer Discretionary: The hardest hit sector of the S&P 500

Sector performance in the S&P 500

The S&P 500 Index, widely used as a benchmark for the US stock market and overall US economy, encompasses 500 of the largest and most successful public companies based in the US. These companies span across 11 sectors, as defined by the Global Industry Classification System (GICS), and so far in 2022 all bar one of these sectors are in the red.

Geopolitical concerns, high and sticky inflation and rising interest rates have placed pressure on the overall US stock market. In fact, it would seem that the only bright spot within the stock market today is the Energy sector, with the remaining sectors all suffering negative returns. And none more so than the Consumer Discretionary sector.

• Overall S&P 500 Index (-15% YTD return)
• Consumer Discretionary (-29% YTD return)
• Real Estate (-25% YTD return)
• Technology (-23% YTD return)
• Telecom (-17% YTD return)
• Materials (-9% YTD return)
• Financials (-9% YTD return)
• Industrials (-5% YTD return)
• Health Care (-2% YTD return)
• Utilities (-2% YTD return)
• Consumer Staples (-1% YTD return)
• Energy (+63% YTD return)

What is Consumer Discretionary?

Today’s society has a few essential spending components such as food, health care and utilities. And unsurprisingly these ‘consumer staples’ have been less impacted by this year’s events since despite inflation running hot and interest rates rising, people will still spend on groceries, medical expenses and their electricity/heating.

The sectors that have been more widely affected are those where expenses are not necessary or considered “discretionary .”The consumer discretionary sector has been the most beaten up this year, and for a good reason. As inflation runs hot, the prices of staple goods/services become more expensive (especially for food and gasoline) which leaves less money available for discretionary expenses. Furthermore, with interest rates rising and high levels of debt – consumers are paying more to service their loans and mortgages, also leading to less discretionary spending. This translates to significantly less demand for providers of discretionary goods/services, at least in theory. 

What exactly is included in consumer discretionary? There are a few broad sub-categories, including:

• Apparel/Textiles (Clothing)
• Automobiles
• Luxury Goods
• Restaurants
• Lodging
• Casinos & Gaming
• E-commerce (e.g., Amazon)

Investment proposition for consumer discretionary

While it is most likely true that consumer discretionary companies will face large headwinds in the form of decreasing demand and cost inflation – both chipping away at margins from both sides. It may also be true that the stock market could have overreacted to the short-term outlook.

Investors are notoriously short-term focused, and while the near-term picture does indeed appear bleak and unpredictable, in the longer-term the consumer discretionary sector still offers a compelling investment proposition, especially once inflation eventually normalizes. 

Consumer discretionary companies within the S&P 500 have powerful brands that have been durable throughout US history. Companies such as Nike, McDonalds, Amazon, and Starbucks will likely be household names for years to come.

Another overlooked factor is the strength of the US labor market, with the latest jobs report indicating extremely low unemployment rates of 3.7%, which is not a characteristic of a full-blown recession. As long as consumers retain their income, they will likely continue to spend, which is a bright spot for consumer discretionary demand.

For a long-term focused investor, the current pullback in the consumer discretionary sector may represent a potential buying opportunity – if the short-term volatility can be overlooked.

A great way to gain exposure to the consumer discretionary sector within the S&P 500 is with low-cost ETFs such as The Consumer Discretionary Select Sector SPDR Fund (XLY).
XLY has seen negative returns and flows this year, however it has strong liquidity, a very low expense ratio and exceptionally good tracking error (essentially tracks the S&P 500 Consumer Discretionary index perfectly).

• YTD Return: -29%
• YTD Flows: -$2.8B
• AUM: $14.1B
• Expense Ratio: 0.1%
• Tracking Error: +0.00 bps

Data for this article is as of December 2, 2022.

Please note this article is for information purposes only and does not constitute investment advice.