The disparity between the performance of the stock market and the real economy is becoming increasingly pronounced, particularly as consumer-facing sectors show signs of distress against a backdrop of broader market gains. The S&P 500 index, buoyed by significant contributions from select sectors, has risen by 13% year to date, building on strong gains in the previous two years of 24.2% and 23.3%.
This upward trend raises concerns among some investors who worry that the stock market may be overvalued, while others believe we are experiencing a sustained bull market fueled by advancements in artificial intelligence (AI). In light of these developments, several key metrics should be considered before investing in S&P stocks, especially as they reach all-time highs.
The technology sector stands out, constituting 34% of the S&P 500 and driving much of the index’s growth since the beginning of 2023. Major players such as Nvidia, Microsoft, Apple, and Oracle are among the “Ten Titans” in this sector, yielding impressive returns. Moreover, the communications sector, heavily dominated by Alphabet, Meta Platforms, and Netflix, has seen stock price increases ranging from 27% to 36% year to date. Over the last three years, Meta’s stock surged by over 440%, and Alphabet increased by 153%.
Additionally, the industrials sector benefits from rising infrastructure investment related to AI, recovering air travel, and robust government spending on defense, contributing to the overall positive performance of the market. However, while business-to-business sectors flourish, the narrative shifts dramatically when focusing on consumer-facing companies, which are currently grappling with a downturn.
Cyclical in nature, the consumer discretionary sector typically thrives during economic expansions but is noticeably underperforming this year. This sector includes retail, restaurants, automotive manufacturers, and household goods, many of which are feeling the pinch from reduced consumer spending. For instance, Home Depot’s growth has stagnated amid a sluggish housing market and elevated mortgage rates. Once high-flying restaurant chains like Chipotle have also seen their stock prices tumble due to decreased consumer appetite for discretionary dining.
Consumer staples companies, such as Procter & Gamble, are facing their challenges as well, as consumers increasingly seek value in household goods. Market leaders like Coca-Cola and PepsiCo report a shift towards health-conscious products, further complicating the landscape for consumer-facing firms. Notably, Costco, a long-term market performer, is down year-to-date, indicating that many established, reliable dividend-paying companies are struggling.
As investors analyze the current climate, a cautious approach is warranted, especially given the signs of weakening consumer demand across many sectors. Evidence suggests that the American middle class is shrinking, which could negatively impact consumer spending and consequently affect sectors reliant on higher sales volumes. Rising living costs, decreasing homeownership rates, and a declining share of household income owned by the middle class all signal that prolonged consumer spending weakness may be on the horizon.
While growth companies in technology, communications, and industrial sectors may have experienced a surge, many stocks in the consumer discretionary, staples, and healthcare sectors are trading at significant discounts to historical norms. This situation does not warrant an indiscriminate sell-off; rather, long-term investors should ensure that high-flying growth stocks justify their elevated valuations.
For instance, Oracle, despite its high valuation, is poised for substantial growth with plans for expanding its data centers and securing lucrative cloud contracts, including a groundbreaking deal with OpenAI. If Oracle meets its ambitious targets for cloud revenue growth, what seems expensive today might turn into a reasonable valuation. Conversely, failure to execute could lead to significant downward pressure on its stock.
In summary, as the stock market has reached new heights, the divergence between the performance of enterprise-facing enterprises and struggling consumer-dependent firms highlights the complexities of current economic conditions. Investors must remain selective and vigilant, focusing on high-conviction opportunities while being aware of the distinct challenges facing consumer-facing sectors in today’s environment.
