A Decent Outlook For Consumer Discretionary ETFs

The Consumer Discretionary Select Sector SPDR XLY, the largest consumer cyclical exchange traded fund, managed a 2018 gain of 1.6 percent, but that performance could have been better if not for a late-year slide in Amazon.com Inc. AMZN.

Amazon, the largest component in XLY other cap-weighted consumer discretionary ETFs, lost about a quarter of its value in the fourth quarter, plaguing the sector and the related ETFs along the way.

What Happened

The sector's struggles late last year could prove to be good news for investors looking for some value in the consumer discretionary area, which often trades at premiums relative to broader equity benchmarks.

“The median stock we cover trades at a 17% discount to our fair value estimate, providing opportunities for investors,” said Morningstar in a recent note. “Roughly half of the consumer cyclical companies we cover are 4- or 5-star-rated, with autos, personal services, and homebuilders trading at the most attractive valuations.”

The $11.82 billion XLY provides exposure to companies “in retail (specialty, multiline, internet and direct marketing); hotels, restaurants and leisure; textiles, apparel and luxury goods; household durables; automobiles; auto components; distributors; leisure products; and diversified consumer services,” according to State Street.

Why It's Important

Even with its recent slide, Amazon accounts for 22.34 percent of XLY's weight, more than double the weight assigned to the fund's second-largest holding. That underscores the growing importance in the consumer discretionary sector.

“For many industries in the consumer cyclical sector, including travel and leisure, entertainment, restaurants, and apparel, digital efforts reign supreme, and e-commerce capabilities can set certain companies up to more easily increase sales,” said Morningstar. “Additionally, for operators that recognize trends and make the necessary operational and technology changes, it can lead to many years of market share gains and premium valuations.”

Overall, Internet and direct marketing retailers account for 28.62 percent of XLY's weight while specialty retailers represent over a quarter of the fund's roster.

What's Next

As holiday shopping data indicates, there is plenty of growth to be had in the e-commerce arena and that is likely to be a long-term catalyst for the consumer discretionary sector.

“We expect e-commerce growth to remain robust in the years ahead. In the U.S., for example, we forecast online retail sales rising at a double-digit clip over the next five years versus less than 4% for the brick-and-mortar channel,” said Morningstar. “That said, a physical footprint is likely to remain important, as brick-and-mortar sales would still represent more than 80% of total U.S. retail sales in 2022.”

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Photo credit: By Álvaro Ibáñez from Madrid, Spain (Amazon España por dentro), via Wikimedia Commons