Higher Rates, Dollar Strength, & Consumer ETFs

It might seem counter-intuitive, but consumer discretionary stocks and the corresponding exchange traded funds might respond more positively to higher interest rates than some investors are giving the group credit for.

The thesis is the Federal Reserve will not raise interest rates until it is entirely confident the U.S. economy can withstand higher borrowing costs. Said another way, the Fed boosting rates could be seen as a sign the U.S. economy is in good shape and that could spark gains for ETFs such as the iShares US Consumer Services ETF (NYSEArca: IYC), Vanguard Consumer Discretionary ETF (NYSEArca: VCR) and the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY).

XLY, the largest consumer discretionary ETF, is the leading performer among the nine sector SPDR ETFs this year.

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 Morningstar. [Discretionary ETFs for a Growing Economy]

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. XLY’s annual expense ratio was recently lowered to 0.14%.