Energy Crunch vs. Consumer Freeze: What Are Stocks Signaling?

US energy stocks are outperforming consumer discretionary stocks by the widest margin in more than 30 years. Does this mean surging energy prices will trigger a deep freeze in consumer spending? Not necessarily. Some consumer companies may be less vulnerable than the market suggests.

Volatile markets often create curious anomalies. This year, as US stocks tumbled, energy stocks surged. The S&P 500 energy sector rose 76% over a 12-month period through June 1, fueled by a global supply crisis. Meanwhile, consumer discretionary stocks have fallen by 12%.

The gap between these two sectors is striking. Energy stocks have outperformed consumer discretionary stocks by 88% on a rolling 12-month basis through June 1—the most since 1989.

Two Sides of the Consumer Coin

Why compare these two sectors? Because energy and discretionary spending are two sides of the consumer coin. Rising energy prices take a bigger bite out of household budgets, as people are forced to pay more for gas and to heat their homes. That leaves less for discretionary spending on everything from clothes to appliances to entertainment.

There’s an implicit message in the performance gulf between these two sectors. We think the market is suggesting that extreme energy inflation will lead to a dramatic reduction in spending. In turn, that will wreak havoc on earnings for consumer discretionary companies, which include retailers, carmakers, hotel chains and restaurant groups.

The risks are real. Aggressive efforts by the Federal Reserve to curb inflation by tightening monetary policy could tip the economy into a slowdown or a recession. And a decelerating economy coupled with high energy prices will no doubt weaken consumer spending power.

Consumers Are in Reasonable Shape

But the US consumer enters this challenging period in reasonable shape. Household balance sheets are stronger than they’ve been in years, with high employment, rising wages and plenty of spare cash accumulated during the pandemic. As a result, we don’t think an energy price crunch will lead people to a drastic decline in spending.

If consumer spending turns out to be more resilient than the market expects, we think the consumer discretionary sector will rebound sharply. To be sure, heading into a downturn, consumer stocks will face big headwinds and investors must be very cautious and mindful of the risks. But by focusing on high-quality companies with clear business advantages, we believe investors can identify select consumer stocks that should pull through the leaner times and deliver rewards in a long-term recovery.