Recent market performance for U.S. consumer-discretionary stocks has been so ugly that it may be a great time to buy.

Such is the conclusion of an analysis done by researchers at SentimenTrader. More than 50 per cent of stocks in the S&P 500 Consumer Discretionary index are trading 20 per cent below their 252-day highs. That setup has preceded a 14 per cent average rally in the next year, with the index pushing higher in 23 of the 28 prior cases, the company’s analysis show.

The pain for the group that includes restaurant operators, makers of yoga pants and cosmetics retailers reflects two-sided risks from the surge in energy prices since the start of the war in Iran: higher production costs and reduced consumer spending on non-essential items. Add those to lingering worries about the labour market as companies shed jobs.

But has the market overreacted?

“This swelling proportion of battered stocks within a highly pro-cyclical sector highlights peak pessimism,” SentimenTrader researchers said in a note to clients. “At this juncture, the bearish macroeconomic narrative has been discounted by the market. This sets up a textbook asymmetric risk/reward scenario for investors willing to step in while sentiment is washed out.”

The S&P 500 consumer discretionary index, home to companies including

Lululemon Athletica Inc.

, Ulta Beauty Inc. and Wynn Resorts Inc., has dropped 10 per cent so far this year, more than double the decline in the broader equities index. The 48-member group is the second-worst performer among the 11 S&P 500 sectors behind financials.

This cohort could be one of the first to rebound when uncertainties begin to ease, according to Mark Hackett, chief markets strategist for Nationwide.

“This group takes a psychological beating from investors moving to the sidelines,” he said. “If we get a resolution to the headwinds we are facing, this sector is seen absolutely as a proxy for overall investor and consumer sentiment and therefore will do quite well, if things return to normal.”

The bet is partly predicated on expectations for a pick-up in earnings growth, owing to a resilient U.S. economy and optimism that the most severe shock of President

Donald Trump

’s

trade war

is over. First-quarter profit is expected to rise for the group after falling in the three months through December for the first time in 12 quarters, data compiled by Yardeni Research show.

Still, it’s unlikely to be smooth sailing for the entire group, according to Hackett, who sees potential decoupling between the so-called “new economy” and more traditional consumer discretionary stocks. Carvana Co., the online platform for buying used cars, and delivery service operator Doordash Inc. may take some time to rebound, said Hackett. Meanwhile, stocks such as casino operator Las Vegas Sands Corp., cruise ship operator Carnival Corp. and Nike Inc. may rebound if consumer sentiment picks up, he added.

A crucial variable for the group is whether energy prices remain elevated long enough to cause a prolonged pickup in inflation that overshadows a tax-refund season expected to add cash to consumers’ wallets, while also keeping interest rates higher for longer. Even before the Iran war started,

inflation

accelerated unexpectedly in February.

U.S.

Federal Reserve

chair Jerome Powell said last week that officials won’t cut

interest rates

until they see progress in reducing inflation. He also said near-term inflation expectations rose in recent weeks and some of the oil shock will show up in core inflation data.

Even as tensions in the Middle East weigh on sentiment, the National Retail Federation (NRF) expects U.S. retail sales to pick up in the first half of the year, with higher-income households driving the majority of the growth. Retail sales are expected to rise 4.4 per cent this year to US$5.6 trillion, according to an estimate from NRF, higher than the 3.6 per cent average annual sales growth over the last 10 years excluding the pandemic.

A clear path to recovery for consumer stocks may not emerge until policymakers cut interest rates. Bond traders currently expect no rate cuts for the remainder of the year.

“Traditionally, it takes a trigger in interest rates to turn the tides in favour of discretionary,” said Gina Martin Adams, chief market strategist at HB Wealth Management.

“It’s very rare that discretionary consumption accelerates in the face of rising energy costs,” Martin Adams added. “Discretionary spending is not likely to improve with the combination of higher energy spending and no job growth.”

—With assistance from Janet Freund.

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