Outlook Remains Solid For Consumer Cyclical ETFs

Using the Consumer Discretionary Select Sector SPDR XLY, the largest exchange traded fund tracking that sector, as the measuring stick, it's accurate to say consumer cyclical stocks are delivering for investors this year.

XLY is up nearly 19 percent year-to-date and resides near all-time highs. Among the 11 sectors tracked by the S&P 500, only technology is outperforming consumer discretionary this year.

What To Know

While consumer discretionary are a tad pricey on valuation, the sector's fundamentals remain solid buoyed by sound consumer-related data points.

“Consumer cyclical sector valuations remain slightly elevated, with a weighted average price/fair value ratio of 1.05, in line with last quarter's valuation,” said Morningstar. “We attribute this to healthy consumer sentiment, low unemployment rates, and stable asset market valuations.”

XLY holds 65 stocks from “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 the issuer.

Why It's Important

While the broader view of the consumer discretionary sector is encouraging, for ETFs like XLY and the Vanguard Consumer Discretionary ETF VCR, price action is largely determined by one stock: Amazon.com Inc. AMZN.

Shares of Amazon represent 23.23 percent of XLY's weight, more than double the weight assigned to the ETF's second-largest holding. At the end of August, Amazon represented 23.3 percent of VCR's weight, more than triple weight the fund assigns to its No. 2 holding.

“We believe market valuations also reflect the fact that consumer cyclical companies are starting to reap the benefits of efforts to cater to the individual demands of consumers,” said Morningstar. “We've long held the belief that those businesses that offer a combination of experience, specialization, and convenience have been best positioned to defend their advantages in an increasingly e-commerce world.”

What's Next

If the U.S. economy and those of other major developed economies remain strong, consumer cyclical ETFs could continue delivering upside for investors in the final quarter of 2018.

“We continue to attribute the bullish market sentiment to a number of factors, including healthy consumer sentiment in the U.S. and many other developed nations, low unemployment rates and wage increases that are helping drive middle-class consumption globally, and equity and housing market conditions that have been conducive to wealth effect spending,” according to Morningstar.

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