Forgotten in the 'Great Rotation', Consumer Stocks Left Behind by Poor Performance

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Investors are pulling out of tech stocks and shifting to lagging sectors, but the consumer goods industry hasn't reaped much benefit.

As of July 31, the Nasdaq Index has fallen 5.7% after hitting a record high of 18,671 points on July 11. Meanwhile, the S&P 500 Consumer Select Sector Index remained nearly flat, the S&P Biotechnology Select Industry Index rose 3.7%, and the $Russell 2000 Index(.RUT.US)$ gained 10.7%.

Weak performance in the consumer sector during earnings season might explain the trend.

Disappointing Q2 Earnings

Forgotten in the 'Great Rotation', Consumer Stocks Left Behind by Poor Performance

$Starbucks(SBUX.US)$, $McDonald's(MCD.US)$, and $Procter & Gamble(PG.US)$ all reported disappointing second-quarter earnings, with revenue growth falling short of expectations. Starbucks' global same-store sales dropped 3%, while McDonald's revenue and profit both missed forecasts, with store sales down 1%—marking the first decline since Q4 2020. $L'Oreal SA Unsponsored ADR(LRLCY.US)$'s same-store sales growth slowed to 5.3%, and Procter & Gamble's revenue growth lagged estimates, with net profit down 7.3%.

A CNBC analysis reveals that 29% of consumer discretionary companies have reported earnings below expectations, nearly double the average miss rate of 16% seen in recent quarters.

The underperformance among consumer sectors largely stems from restrained discretionary spending. The University of Michigan's Consumer Sentiment Index for July fell to 66.4, the lowest since last November. Analysts suggest that high prices continue to erode purchasing power, particularly among low-income households.

Franklin Templeton Investments' Senior Vice President Max Gokhman noted that data indicates consumers are starting to slow down, with low-income consumer loans rising and spending decreasing.

Goldman Sachs analyst Natasha Dragicevich also warned clients that the consumer earnings season has had a weak start, with few positive surprises so far. Both high-end and low-income spending are showing signs of strain.

However, some consumer companies have shown resilience. Colgate-Palmolive's Q2 sales grew 9.0%, with volume sales up 4.7%, the best performance since 2020. However, prices in the US region fell slightly by 3.3%.

Coca-Cola's organic sales increased by 15% in the second quarter, with North American sales down only 1%, while pricing and sales mix increased by 11% year-on-year. This indicates that although consumers are cautious, the company is more capable than its peers to push up prices, which may suggest its strong brand power.

Weak consumer demand in China

Consumer giants are seeing widespread declines in China. Starbucks' same-store sales plunged 14%, Procter & Gamble's sales in Greater China fell 9%, and L’Oréal's revenue in China and North Asia dropped over 2%.

Luxury consumption in China is notably weaker. Several luxury groups reported tepid demand from Chinese consumers. LVMH's Asia-Pacific (excluding Japan) revenue fell 14%, marking China as its only declining market in the first half. Cartier-owner Richemont said sales were flat in the quarter ending June, as growth in the US and Europe offset a sharp 27% decline in China.

China's retail sales growth from April to June was 2.3%, 3.7%, and 2.0%, respectively, all below the expected 4.0%-4.5%. Weak consumer confidence and employment pressures are dampening demand.

A research report by CITIC Securities on August 1st indicated that considering base effects and CPI expectations, consumption data may stabilize in Q4 2024. The July 30th Politburo meeting emphasized boosting domestic demand, suggesting potential support for consumer spending.

Focus on the Long Term

Earnings season so far indicates consumers continue to feel the pinch of inflation. Following the Federal Reserve's policy meeting that concluded Wednesday, Chair Jerome Powell signaled that central bank officials are poised to cut interest rates in September, barring a setback in inflation progress.

Over the long term, consumer stocks differ from tech stocks in that they don't typically exhibit overall excess returns, largely due to the presence of many average-performing companies. The consumer index isn't one that significantly outperforms the market.

However, the sector does have standout performers that rival the gains seen in high-tech stocks.

Over the past 30 years, the top-performing consumer stock has been $Monster Beverage(MNST.US)$, surging more than 150,000%. This ranks it third among all U.S. equities, trailing only Nvidia and Amazon.

In recent years, some consumer stocks have delivered impressive returns. Since 2022, shares of $e.l.f. Beauty(ELF.US)$, $Deckers Outdoor(DECK.US)$, and $Abercrombie & Fitch(ANF.US)$ have surged 405%, 308%, and 147%, respectively, far outpacing the $Nasdaq Composite Index(.IXIC.US)$'s 9.9% gain over the same period.