A rise in consumer spending in July has some investors betting on a continued strengthening of the economy and the overall stock market. However, active traders who pay attention to the charts might want to dampen their outlook because recent breaks below key support levels suggest that the rise in bullish sentiment for the consumer discretionary sector could be short lived.
For those new to finance, consumer discretionary spending is defined as expenses that are not necessary for the successful operation of a household. The best way to think of this type of spending is in terms of wants versus needs. Discretionary spending is when consumers buy goods they want just because they can or because have extra money in their accounts. Unsurprisingly, when economies are strong, discretionary spending rises. Conversely, weakness across the consumer discretionary sector could be an early sign of an economic reversal.
Taking a look at the chart of the Consumer Discretionary Select Sector SPDR Fund, you'll see that the price has been trading along a clearly defined trendline for most of 2017. The lack of conviction of the bulls over recent sessions suggests that the upward momentum is weakening, and a few more closes below $90.35 would be a technical sign of a trend reversal. (For more, see: Consumer Spending as a Market Indicator.)
Entertainment is usually a segment of the market that is strongly associated with discretionary spending. Taking a look at the top holdings of the XLY fund, Disney is one of the most well known companies in the space, with a weighting of 5.72%. From the perspective of an active trader, given the recent close below the support of the trendline as well as the 50-day and 200-day moving averages, the trend for Disney is now clearly in favor of the bears.
In fact, the bearish crossover between the two long-term moving averages is one of the most common long-term sell signals, known as the death cross. This type of crossover is generally used to mark the beginning of a long-term downtrend. For further confirmation, active traders will likely use the crossover between the moving average convergence divergence (MACD) and its signal to suggest that prices are headed lower over the weeks and months ahead. (See also: The Spending Habits of Americans.)
Another company that is commonly associated with consumer spending is Starbucks. While many would disagree, spending money daily on a cup of coffee is not a necessary expense for the successful operation of a household.
By taking a look at the chart, you'll notice that the price of the world's most famous coffee shop has dropped below the combined support of a defined trendline range (as shown by the horizontal trendline) and two major long-term averages. The breakdown and subsequent move lower suggests that the bears are now in control and that a more significant move lower could be in the cards. (For more, see: Starbucks Stores Are Finally Cannibalizing Each Other: BMO Downgrades.)
The Bottom Line
Strong levels of discretionary spending such as those reported in July are often an indicator of a strengthening economy. However, based on the charts of key financial assets within the consumer discretionary sector, it appears as though bearish trading signals could be warnings of a move lower over the coming weeks and months. (For more, see: Why Consumers Are the Biggest Threat to the Economy.)
Charts courtesy of StockCharts.com. At the time of writing, Casey Murphy did not own a position in any of the assets mentioned.