The consumer discretionary sector and related exchange traded funds have outperformed the broader market. With a growing U.S. economy, consumer spending may still pick up pace, especially as we get into the holiday season.
“Lower gas prices and higher employment have offset consumers’ concerns about anemic real wage growth, higher cost-of-living expenses on items such as rent and health care, and broad stock market weakness,” writes Mroningstar analyst Robert Goldsborough. “And even recently declining consumer sentiment readings still are well above their levels of a year ago.”
Consumer sentiment was 85.7 in September, down from 91.9 in August, Bloomberg reports.
Nevertheless, consumers remain confident and optimistic. Goldsborough points out that more affluent consumers are showing very strong sentiment while lower- and middle-income consumers are taking a more middle viewpoint.
Meanwhile, consumer sector stocks have been outperforming this year. Year-to-date, the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) returned 4.6%, whereas the S&P 500 index dipped 3.8%.
XLY is fairly top heavy and includes exposure to retail firms, restaurants, media companies, apparel and luxury goods companies, automobile manufacturers and leisure industries.
“Investors interested in this ETF should beware, however. Consumer discretionary companies have a consistent history of outperforming in the early stages of a business cycle and underperforming late in a business cycle,” Goldsborough warned. “So this certainly is not a fund that one would want to own if one believes that the U.S. economy is headed toward a recession.”
Retailers make up a large portion of the underlying holdings. E-commerce and greater mobile commerce usage has also been a big game changer in the industry, especially with more consumers using online sources like Amazon (NasdaqGS: AMZN), which XLY holds.
With the U.S. dollar strengthening, currency risk is also a concern for many investors. However, foreign currencies and global consumer spending do not have a major effect on U.S. consumer discretionary sector, according to Goldsborough.
Additionally, investors may also find other options, including the iShares US Consumer Services ETF (NYSEArca: IYC), Vanguard Consumer Discretionary ETF (NYSEArca: VCR), Fidelity MSCI Consumer Discretionary Index (NYSEArca: FDIS), First Trust Consumer Discretionary AlphaDEX Fund (NYSEArca: FXD).
Unlike the other consumer sector ETFs, IYC includes non-discretionary retailers, like Wal-Mart (NYSE: WMT), which may help diminish volatility.
VCR includes a more diversified take on the sector with 385 component holdings and comes with a cheap 0.12% expense ratio.
FDIS, the more recent entrant to the space, also charges a cheap 0.12% expense ratio, but it is smaller than its competitors and is more thinly traded. Potential investors should utilize limit orders to better control trades.
FXD follows an enhanced, or smart-beta index that selects holdings based on value and growth factors. Consequently, the portfolio is a less growth-oriented than XLY or VCR.
Additionally, the iShares Global Consumer Discretionary ETF (NYSEArca: RXI) provides a more diversified global focus, which includes more international name brands like Toyota (NYSE: TM), Ford (NYSE: F), Daimler and Honda (HMC).
For more information on the consumer sector, visit our consumer discretionary category.
Max Chen contributed to this article.