Where to Shop in the Consumer Discretionary Sector

CFRA today lowered our recommended exposure to the S&P 500 Consumer Discretionary sector to marketweight from overweight. CFRA Chief Investment Strategist Sam Stovall noted that with commodity prices, wage pressures, transportation/freight rates, and numerous other factors pressuring costs, profit margins for the sector are likely to be squeezed. In addition, Fed Chair Powell recently said it was unlikely that supplemental unemployment payments from the federal government would extend past September. CFRA thinks this could cause consumers to start to pull back on discretionary spending. Even though the sector is expected to record 2021 EPS growth of 39%, according to S&P Capital IQ’s Consensus Estimates, vs. the S&P 500’s projected 31% growth rate, the sector sports the highest absolute P/E premium of all 11 sectors, based on next 12-month EPS estimates. Finally, Stovall added that Consumer Discretionary’s nine-month relative price performance places it among the bottom four sectors.

There are still many ETFs in the sector that remain attractive to support a recommended 12% weighting. 

CFRA classifies 16 ETFs as focused on the U.S. Consumer Discretionary sector, eight of which earn a five-star or a four-star, based on the high likelihood of their outperforming U.S. Sector peers including those focused on Health Care or Information Technology. CFRA’s ETF star rating approach combines holdings-level analysis, including our qualitative stock recommendations, as well as performance, costs, and sentiment indicators. While our sector recommendations are based on likelihood of outperformance of the S&P 500, our ETF recommendations are assessed relative to the more than 200 U.S. Sector ETFs.

XLY and Invesco S&P 500 Equal Weight Consumer Discretionary ETF (RCD) remains appealing relative to sector peers despite different exposure to same stocks. Five-star rated XLY is the market-cap weighted portfolio of Consumer Discretionary stocks in the S&P 500. Nine of its top-10 holdings, which represent approximately 70% of assets, are CFRA Buy or Strong Buy recommendations, including Amazon.com (AMZN), Nike (NKE) and TJX Companies (TJX). XLY charges a modest 0.12% expense ratio and gathered $200 million of new money in 2021.

Four-star rated RCD holds the same S&P 500 stocks but uses an equal-weighted approach. As such, its top-10 holdings represent just 18% of assets and DHI is more heavily weighted than AMZN. RCD charges a higher 0.40% fee but has pulled in approximately $545 million this year.

XHB provides targeted exposure to housing-related industries CFRA favors. Despite having homebuilder in XHB’s name, the ETF is more diversified than might be expected. Homebuilding (32% of assets) companies held in the portfolio include D.R Horton (DHI), PulteGroup (PHM) and Toll Brothers (TOL), but the fund also has stakes in home improvement (11%) and home furnishing retail (9%) companies such as Home Depot (HD) and TJX. However, building products (38%) is the largest sub-industry and the fund holds some stocks CFRA finds attractive including Carrier Global (CARR) and Masco Corp. (MAS). XHB charges 0.35% expense ratio and has gathered approximately $430 million to start the year.

Meanwhile, CFRA has a two-star recommendation on iShares U.S. Home Construction ETF (ITB), a peer of XHB, due to our higher risk concerns.

Originally published by CFRA

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