A port-in-the-storm trade if the consumer continues to get pinched by rates and inflation

The consumer, making up 70% of the U.S. economy, is being hit by higher interest rates and sticky inflation. If this trend continues, there’s a defensive options trade to capitalize on it. It is often said that the U.S. economy is consumer-driven. The reason? Consumer spending, also known as personal consumption expenditures (PCE), typically represents about two-thirds of the U.S. GDP. This makes it a crucial driver of the nation’s economic activity and a key indicator of overall economic health. Consumer spending includes expenditures on goods (durable and non-durable) and services. It has long been expected that the sharp inflation over the past three years might impact consumer behavior, but some recent earnings results, such as those from Starbucks last week, suggest consumers are pulling back more sharply than anticipated. The company’s reduced guidance suggests same-store sales could actually decline modestly. Tesla saw a sequential unit sales decline despite aggressive price cuts. While that is attributed to easing consumer demand for EVs, dealer inventories of ICE vehicles have recovered significantly since the pandemic. As inventories returned, so did larger discounts. Some have been surprised that auto sales have been as strong as they have despite the recent increase in interest rates, and automakers and dealers are likely among those hoping for interest rate decreases to help support sales. The $44,186 average sales price that JD Power reported for the month of March represented a 3.6% decrease year over year. Investors are naturally eyeing next week’s PPI and CPI inflation data as key indicators of if and when the Fed may reduce interest rates — although the Federal Reserve itself tends to prefer the PCE Deflator which will be released later in the month. If inflation data comes in hot, rising prices may continue to hurt foot traffic at stores like Starbucks and if rates remain high, a hoped for boost provided by lower financing costs for larger ticket items such as autos may not materialize. Where to invest Where might an investor turn? Away from consumer discretionary and towards consumer staples. The Consumer Staples Select Sector ETF (XLP) is trading 21 times trailing earnings and about 19.6 times forward earnings estimates versus 25.7 times trailing and 22.83 times forward for the Consumer Discretionary Select Sector Index. XLP 1Y mountain Consumer Staples Select SPDR (XLP), 1-year So, the consensus view is that staples will see roughly 7.1% year over year earnings growth versus 12.6% for the consumer discretionary sector, but if inflation pinches consumers and delays rate cuts, that earnings growth gap could narrow. Staples are also viewed, much like utilities, as a port-in-the-storm. The XLP pays a roughly 2.9% annual dividend as well. The trade The fact that staples stocks exhibit such low volatility also tends to depress options premiums, so it’s possible to make a bullish bet by simply buying a longer-dated call at relatively low cost, such as the September $77 XLP calls. Buy XLP Sep. 20 $77 call Remember holders of call options don’t get dividends, only holders of the underlying shares do, so if that income is part of the appeal for you, stick to the basics, just buy the shares. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.