What does it mean when we learn that consumer sentiment drops to the lowest level since 12/2011? For the bulls, it means that any setback in consumer “feelings” will be offset by the Federal Reserve’s easy money policy; that is, the Fed will not quit its bond-buying, interest rate lowering until exceptional employment prospects spur greater consumption.
For the bears, however, many believe the writing for a substantive sell-off is on the “Wall.” In spite of the fact that SPDR Select Consumer Discretionary (XLY) and SPDR Select Consumer Staples (XLP) have been notching high after all-time high, both fell further on 3/15/2013 than most of the other key sector ETFs.
Naturally, bulls regard the slight selling pressure as little more than a knee-jerk reaction. They are also pointing to the fact that what consumers feel (sentiment) often does not correspond to what they do with their money.
Not surprisingly, the bearish guidance involves a “Sell in April and Avoid a Pain Pill” opportunity. They contend that Q1 2013 earnings will show the adverse effects of the¬†lower take-home pay that began at the start of the year. And the bears decry that the automatic spending cuts that began last month will inevitably reduce government jobs; they believe the numbers will look dismal in the March and April labor stats.
It may be beneficial to take a longer-term view of Consumer Discretionary (XLY) to take a quick respite from the bull-bear debate. Over the last decade, then, what can we learn about the performance of XLY relative to the broader S&P 500 benchmark?
The chart above is incredibly intriguing. The most obvious thing that pops out is the fact that an unwavering faith in the strength of the U.S. consumer resulted in a total return that was 50% (5000 basis points) greater than buying-n-holding the benchmark. On the surface, this would seem unassailable proof that the consumer sector has its advantages.
Yet the first 6 years of the decade showed little difference in performance whatsoever. In fact, due to the housing collapse, the downside slide in consumer spending began first with XLY during the 2007-2009 stock market crisis. Still, the end result after 6 years was decidedly similar.
So if our current 4-year bull market tells us anything, it tells us the power of the Fed’s quantitative easing; that is, if the central bank is able to keep interest rates below free market levels — if government powers can create an environment where consumers will borrow to buy home appliances, cars and 54-inch TVs — consumer-oriented companies can crush earnings expectations. Better earnings result in higher stock prices… higher stock prices fuel momentum and even higher stock prices.
There’s only one problem with the idea that funds like Vanguard Consumer Discretionary (VCR) or SPDR Select Consumer Discretionary (XLY) are unbreakable. The problem? Reversion to the mean.
History teaches us time and again that outperforming sectors become underperforming sectors and vice versa. In this case, XLY’s stratospheric rise over the last 4 years is likely to revert back to the mean performance of the S&P 500. Right now, that’s a fairly depressing pullback.
Nevertheless, don’t expect Consumer ETFs to flounder overnight. Since its remarkable success is largely tied to the low interest rates that consumers have enjoyed — since the Fed isn’t going to let rate increases harm a perception that employment/GDP progress is just around the bend — Consumer ETFs should be able to hold their own.
If you’re worried about rising rates, however, you might consider diversifying in the space. Market Vectors Retail (RTH) diversifies between defensive toilet paper and tooth paste stocks as well discretionary spending at Amazon and Home Depot. iShares Global Consumer Staples (KXI) diversifies 50% with non-U.S. brand name biggies like Unilever and Nestle.