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There are two things wrong with this crucial sector

There are two things wrong with this crucial sector

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There are two things wrong with this crucial sector

There are two things wrong with this crucial sector
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The worst performing sector in the S&P 500 is still the most expensive.

The consumer discretionary sector, containing the likes of Home Depot, Disney, Amazon and Comcast (CNBC’s parent company), is trading at 20.9 times its trailing 12-month earnings, according to Bespoke Investment Group. That makes it the highest relative price of any sector in the benchmark S&P 500 index.

Meanwhile, the consumer discretionary sector is also the worst performing of all the S&P 500 sectors in 2014. It’s down 1 percent while the nine other sectors are up for the year.

Sector

Year-to-date performance

Utilities

14.0%

Energy

13.1%

Health Care

9.0%

Materials

7.7%

Information Technology

7.3%

Financials

4.8%

Consumer Staples

4.7%

Industrials

4.1%

Telecommunications

2.7%

Consumer Discretionary

-1.0%

 

Gina Sanchez, founder of Chantico Global, believes things will get worse for the sector after years of outperforming the S&P 500 index of which it is a part.

“I believe there’s a credit bubble,” said Sanchez, a CNBC contributor. “That credit bubble extends to consumers and, that has definitely bid up consumer discretionary over the last few years. If you consider the fact that we had nascent wage growth and the fact that the labor participation [rate] is still low and dropping, that tells me that consumers are likely leaning on credit to fund their lifestyles. At some point, they’re going to have to pay that back.”

Disappointing numbers from several large retailers like Wal-Mart and Home Depot indicate that “that consumer bubble can’t go on forever,” said Sanchez. “From a fundamental point of view, we could see continued weakness in consumer discretionary.”

 

Top 10 Consumer Discretionary Companies

Year-to-date performance

Ford

9.4%

Disney

8.3%

McDonald’s

5.0%

Priceline

3.7%

Time Warner

2.2%

Comcast

0.9%

Twenty-First Century Fox

-2.0%

Starbucks

-2.1%

Home Depot

-2.1%

Amazon

-17.9%

 

Richard Ross, global technical strategist at Auerbach Grayson, sees the technicals as negative for the sector as well. He is particularly concerned with the Consumer Discretionary Select Sector SPDR (XLY), the ETF that tracts the sector.

“Underperforming and overvalued is no way to go through college,” said Ross, channeling “Animal House” Dean Vernon Wormer. “I think the consumer discretionary stocks should be sold right here.”

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Ross’ short-term chart of the XLY shows two retracements toward the 200-day moving average since the start of the year. The second retracement had a false breakdown below the 200-day. “That’s potentially a sign of things to come,” said Ross, a “Talking Numbers” contributor. “That’s the first violation of the 200-day since 2011. That’s a long time to be above trend.”

A double top in late May and early June also raises flags for Ross. “We’re really having trouble in here and that double top tells me we’re going lower,” he said. “We could retest the 200-day.”

The 200-day moving average on the XLY is around $64.12 per share, about 1.6 percent below current levels.

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The longer-term chart makes Ross even more negative on the XLY. The ETF has generally traded above its 100-week moving average since 2009. “The last time we tested it back in 2011, [with] a 20 percent correction,” said Ross. “Yes, we’ve tested it and held. But, I can see that same sort of thing unfolding here today.”

Comparing the XLY to the S&P 500, Ross points out that “we’ve outperformed [the S&P 500] over the last five years. I think it’s time for a little mean reversion, a little underperformance, which we’re already seeing, and another test of that 100-week moving average. That’s about 15 percent down move from here.”

To see the full discussion on the consumer discretionary sector and the XLY, with Sanchez on the fundamentals and Ross on the technicals, watch the above video.

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