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.”
The discretionary ETFs include a good tilt toward retailers. For instance, XLY includes 18.6% specialty retail, 13.3% internet retail and 5.9% multiline retail. VCR holds 4.5% apparel retail, 3.0% auto retail, 6.9% home improvement retail, 1.0% homefurnishing retail and 10% internet retail. IYC also includes 33.1% retail.
Alternatively, investors may look to other areas of the market that are less sensitive to household consumption trends, such as the tech sector.
For tech exposure, there are a number of broad ETFs to select from, including the Technology Select Sector SPDR (NYSEArca: XLK), iShares U.S. Technology ETF (NYSEArca: IYW) and Vanguard Information Technology ETF (NYSEArca: VGT). XLK tracks the tech sector from the S&P 500 index. IYW also tracks a similar group of tech companies taken from the Dow Jones U.S. Technology Index and does not include telecom stocks. VGT, on the other hand, includes a small position in information technology services companies. [Time for Some Tech With a Favored ETF]
iShares US Consumer Services ETF
For more information on the consumer sector, visit our consumer discretionary category.
Max Chen contributed to this article.