Ahead of Fed Consider…Discretionary ETFs?

August 21st at 10:00am by Tom Lydon

The Federal Reserve releases minutes from its most recent monetary policy meeting later today. Traders and investors are hoping the Federal Open Market Committee minutes provide defined clues about the central bank’s next steps regarding its $85 billion-per-month bond-buying program. Hints or overt mentions of tapering or an outright end to quantitative easing could spark further upside for Treasury yields.

Ten-year Treasury yields have jumped 13% in the past month and nearly 39% since May 22 when tapering chatter began in earnest. That yield spike has inflicted damage on an array of previously beloved asset classes and sectors including preferred stocks, REITs and utilities shares. [Preferred Stock ETFs Flashing Ominous Signs]

Should the Fed hint at imminent tapering causing further declines for Treasury bonds, investors may want to consider ETFs from a surprising sector: Consumer discretionary. Since 10-year yields started rising on May 22, the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) is up 2.7%, the best performance among the nine sector SPDR ETFs over that time. The Vanguard Consumer Discretionary ETF (NYSEArca: VCR) is up an even more impressive 3.2%. [Discretionary ETFs Could See Falling Prices]

Rising rates benefiting discretionary stocks and ETFs may run counter to conventional wisdom that higher borrowing costs will turn spendthrift consumers into frugal savers. However, stout consumer confidence data combined with rising rates can be a favorable scenario for discretionary names.

Since 1967, stocks have risen at a 12.8 percent annualized rate in months when bond yields and the Conference Board’s consumer confidence measure rise in tandem, Joshua Zumbrun and Victoria Stillwell reported for Bloomberg, citing Wells Capital Management’s James Paulsen. Currently, consumers are the least pessimistic in more than five years and homebuilders are the most upbeat since 2005, according to Bloomberg.

On a historical basis, discretionary stocks have thrived in rising rate environments. Consumer discretionary stocks have historically gained about 29 percent during periods when interest rates rise, according to Bespoke Investment Group.

Of XLY’s top-10 holdings, a group that represents about 47.5% of the fund’s total weight, seven of those stocks have traded higher over the past three months. Dow components Walt Disney (NYSE: DIS), Home Depot (NYSE: HD) and McDonald’s (NYSE: MCD) are the laggards.

Consumer Discretionary Select Sector SPDR

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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