Why A Netflix Departure From This Consumer ETF Could Drive A Bearish Stance

The Consumer Discretionary Select Sector SPDR XLY, the largest exchange traded fund tracking the sector, was up 6.6 percent year-to-date as of Monday. That's the second-best performance among the nine legacy sector SPDR ETFs, trailing only the Technology Select Sector SPDR XLK.

Despite XLY's solid performance this year, some analysts are unenthusiastic about the fund's prospects. AltaVista Research has an Underweight rating on the benchmark consumer discretionary ETFs. That rating implies below-average appreciation potential, according to the research firm.

“Typically, funds in this category consist of stocks trading at relatively expensive valuations and/or having below-average fundamentals,” said AltaVista.

Something To Consider

XLY, as is the case with rival cap-weighted consumer discretionary ETFs, allocates over 20 percent of its weight to media stocks. This is a relevant point: later this year, many media names that reside in the consumer discretionary sector will be ushered over to the telecommunications space, which is being reconfigured as communication services

While index providers MSCI and Standard & Poor's have not announced the specific names that will be making the transition, it is reasonable to expect some of XLY's marquee names will move. That could include the likes of Walt Disney Co. DIS and Netflix, Inc. NFLX, XLY's fourth- and fifth-largest holdings, respectively.

Shares of Netflix are up nearly 120 percent over the past year. If that stock continues on a pace even close to that figure upon departing consumer discretionary ETFs, the funds could see their performances languish.

The Amazon Issue

Amazon.com Inc. AMZN is the primary driver of XLY's performance. That stock accounts for 21.3 percent of the ETF's weight, or more than triple the weight assigned to Home Depot Co. HD, XLY's second-largest holding. Amazon and Netflix, among others, are propping up XLY at a time when three of its top 10 holdings, including Home Depot and Walt Disney, are among the 15 members of the Dow Jones Industrial Average that are in the red year-to-date.

Better GDP growth, tax cuts and soaring consumer confidence provide a solid fundamental outlook,” said AltaVista. “However, forecasts for rising margins appear optimistic to us in light of the unrelenting competition between brick-and-mortar retailers and online firms like Amazon. Meanwhile the sector's P/E remains above the multi-year range of 18-20x even after last month's correction, making it richly valued in our view.”

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