U.S. growth has been fueled by debt-driven consumption. However, consumers have trimmed down debt, potentially diminishing the outlook for consumer discretionary sector-related exchange traded funds.
Year-to-date, the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) rose 10.1%, Vanguard Consumer Discretionary ETF (NYSEArca: VCR) increased 9.1% and iShares US Consumer Services ETF (NYSEArca: IYC) gained 8.7%.
However, Russ Koesterich, Managing Director and BlackRock’s Global Chief Investment Strategist, warned that consumer activity remains soft, with June’s negative retail sales numbers pointing to subdued spending. Adjusted retail sales growth at 1.4% year-over-year was close to its lowest level since 2009.
Koesterich suggested that U.S. consumers are still experiencing the lingering effects of the financial downturn and have cutback on their spending habits.
“Consumers are unlikely to revert to their old spending habits any time
soon,” Koesterich said. “The reason: The multi-decade debt binge, which supported household consumption prior to the financial crisis, has now come to an end.”
Household debt previously expanded at an average annualized rate of over 9% between 1945 and 2007 but topped out in 2007. Historically, household consumption has increased by 0.2% for every one percentage point increase in household debt.
However, since the economy began picking up pace, household debt has increased at a much slower pace of less than 1% annualized. Looking ahead, Koesterich is doubtful that U.S. households will be able to maintain the same rate of debt they held before the financial crisis. Consequently, Americans will not be able to sustain previous levels of debt-fueled consumption.
“Higher consumption fuels economic growth, so there are several implications for markets if consumers spend less,” Koesterich added. “Among them: more modest growth, low-for-long interest rates and a household sector that comprises a relatively smaller percentage of the economy than it did at the peak in 2007. For equity investors, this means being selective when buying consumer stocks, given that retailers are facing a bigger battle for market and wallet share.”