As Retail Sales Pick Up, Two Consumer Discretionary ETFs Returned to Spotlight

As we recently noted, the current earnings reports by the U.S. department store chains appeared to be uncharacteristically strong. U.S. retail sales increased 1.7% in October, while core retail sales rose 1.6% on the month. Several investment banks wrote in their recent research notes, that they expect an equally strong holiday shopping season, fueled by deferred physical shopping “nostalgia”. Inflation is another great reason to hurry up with our holiday shopping.

Durables and apparel look the most attractive subsectors in this respect: they are still a bit undervalued and above the quality baseline based on 11-year averages. This segment includes household equipment, leisure products, textile, apparel and luxury goods. General retail looks quite solid too: it is close below the baseline in valuation, but above it in quality. Having said that, auto and components look overvalued by over 30% relative to historical averages. In contrast, the public services subsector, which includes hotels, restaurants, wellness and diversified individual services, has quite poor metrics: the quality score is at the minimum value. The median 12-month earnings yield came back a bit above zero, but the median ROE still is in negative territory. Many companies have taken additional debt to survive lockdowns and travel bans, and some consumers may have changed their habits in a lasting way.

The Fidelity MSCI Consumer Discretionary Index ETF (FDIS) has been tracking the MSCI USA IMI Consumer Discretionary 25/50 Index since 10/21/2013. It has a total expense ratio of 0.08%, which is quite low. Another sector-focused ETF is Consumer Discretionary Select Sector SPDR (XLY), which has a higher expense ratio of 0.12%. The latter fund was launched by State Street Global Advisors and is managed by SSGA Funds Management. The fund invests in stocks of companies operating across consumer discretionary sectors, both in growth and value stocks with diversified market capitalization. It seeks to track the performance of the Consumer Discretionary Select Sector Index, by using the full replication technique. Currently, its major holdings include Amazon.com (AMZN), Tesla (TSLA), McDonald's Corp.(MCD), Home Depot (HD) and Nike (NKE).

Unlike XLY, FDIS holds 296 stocks. The aggregate weight of the top 10 holdings is just 59%, although about 35% is attributed to the top two names. So, FDIS offers a better diversification, in our view. Amazon and Tesla represent 21.8% and 13.4% of the fund’s asset value.

In terms of FDIS composition, Amazon.com Inc. (AMZN) and Tesla Inc.(TSLA) still occupy the top two positions – understandably, due to their huge market capitalizations, followed by Home Depot (HD), Nike (NKE), McDonald's Corp.(MCD), Lowe's Cos. (LOW), Starbucks (SBUX), Target Corp.(TGT), Booking Holdings (BKNG) and TJX Companies (TJX).