Sector ETFs tied to financial and consumer discretionary stocks are outperforming the S&P 500 this year as American households clean up their balance sheets and begin borrowing more after the credit crisis.
The ratio of consumer debt to income is at its lowest level in over three decades, consumer loans are rising, and the share of delinquencies on bank cards is the smallest since 1990, according to Bloomberg News.
“Household finances are in the best shape in decades,” said Joseph Carson, director of global economic research at AllianceBernstein, in the article. “We now have a creditworthy borrower. It’s a powerful ingredient” for the U.S. expansion and “definitely a step up from where we have been.” [Consumer ETFs Strong on Rising Sentiment]
Improving sentiment and economic data have propelled cyclical sector ETFs in 2013. For example, Financial Select Sector SPDR (NYSEArca: XLF) and Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) are both up about 28% year to date, while the S&P 500 has gained 21%, according to Morningstar. [Financial ETF Sees Big Inflow]
Cyclical ETFs may continue to outperform defensive, dividend-paying sectors that have been bid up to expensive valuations by investors looking for income and safety in recent years. [Sector ETFs for Rising Rates and an Improving Economy]
“Many defensive stocks are at their peaks of profitability and valuation—and have outperformed cyclical stocks. The reason: record-low bond yields. Investors bought quality companies with predictable earnings and dividend income. This led to the bondification of the equity market,” according to a recent note from BlackRock, which manages the iShares ETFs.
“Be wary of sectors with extreme positioning. This is why we prefer to slowly swap some crowded income plays and expensive high-quality stocks for cheaper cyclicals at this time,” it added. [Dividend ETFs: The ‘Bondification’ of the Stock Market]
The U.S. is entering a new, “stronger growth phase” as improving finances jumpstart borrowing, Carson said in the Bloomberg article. Credit will drive consumer spending, generating business investment and jobs to extend the expansion well beyond a fifth year, he added.
U.S. consumption makes up over two-thirds of the economy.
Financial stocks “will continue to outperform as they’re right at the heart of the credit-creation process, which is becoming noticeable,” added James Paulsen, chief investment strategist at Wells Capital Management, in the report.
While consumer cyclicals have less room to build on their big gains, if unemployment falls close to 6%, “all of a sudden you’d see a lot more demand for credit” and spending, he said.