Consumer Discretionary ETFs: Too Discretionary?

Jonathan Bernstein, Contributing Editor
August 14, 2010

Consumer discretionary ETFs look pricey. The discretionary sector had a strong run in 2009 and the first half of 2010. Now, consumer staples are cheaper. Broad market benchmarks like the S&P 500 are cheaper. Recent consumer data does not seem to bear out this confidence.Consumer sentiment is off. June consumer sentiment came in at 50.4. This was twice as good as in March of 2009, but way below the 90 level economists associate with a stable economy. Consumers are also economizing. According the Department of Commerce's Bureau of Economic Analysis, a percentage of disposable income, personal savings is currently running above 6% (as opposed to about 2% before the mortgage crisis).Very negative consumer sentiment is important for the discretionary sector. When sentiment is strong, consumers tend to be willing to spend on discretionary products and services. When sentiment is weak, consumers cut back on discretionary purchases.Credit is an important consideration too. According to Federal Reserve statistics, overall revolving credit decreased at an annual rate of 9.5% in the second quarter of 2010. Federal Reserve numbers have consumer credit contracting 16 of the past 17 months.The chart below compares the Consumer Discretionary Sector SPDR (NYSEArca:XLY - News), the Consumer Staples Select Sector SPDR (NYSEArca:XLP - News). Through April discretionary led staples by 2-1. Performance in the consumer discretionary is often compared with performance in the consumer staples sector. The chart shows XLYs extraordinary run over the last 12 months. XLY is the benchmark consumer discretionary ETF. It holds automobile, restaurant, hotel and entertainment stocks. XLP holds companies producing staples. Staples are goods and services deemed essential to consumers.The chart shows that XLY is sensitive to consumer and investor sentiment and the market cycle broadly.At current levels, XLY has a Price/Earnings ratio of 17 as compared to 14 for XLP, and 15 for the S&P 500. This means that discretionary companies like Comcast, Disney and Home Depot are priced higher in terms of their earnings compared to staples companies like Coke, Pepsi and Walmart.One reason for this pricing is the relative popularity of the risk trade coming off the bottom of the market in March of 2009. During this period investors bought staples and shunned all discretionary retail.An historically volatile sub-sector of consumer discretionary is retail. SPDR S&P Retail ETF (NYSEArca:XRT - News) holds companies like Dicks Sporting Goods, the Dress Barn, and Footlocker. Traders may find it useful to focus a consumer discretionary position by mixing in a long or short position in XRT.There are also several Proshares ETFs popular with traders. They are different from the plain vanilla consumer discretionary ETFs in several ways. First, all use leverage-- used either in going long the sector: ProShares Ultra Consumer Goods (NYSEArca:UGE - News) and ProShares Ultra Consumer Services (NYSEArca:UCC, or to short it: ProShares UltraShort Consumer Goods (NYSEArca:SZK - News) and ProShares UltraShort Consumer Services (NYSEArca:SCC - News). Second, these funds are expensive, with expense ratios of 0.95% compared to 0.23% for XLY. Third, these funds tend to shrink and grow in size according to popularity and market direction far more dramatically than other consumer discretionary ETFs. All are probably too speculative and expensive for most investors.A list of consumer discretionary ETFs follows:Broad Consumer DiscretionaryConsumer Discretionary Select Sector SPDR (NYSEArca:XLY - News)Vanguard Consumer Discretionary VIPERS (NYSEArca:VCR - News)Sub-Sector Consumer DiscretionaryiShares Dow Jones U.S. Consumer Goods Sector Index Fund (NYSEArca:IYK - News)iShares Dow Jones U.S. Consumer Services Sector Index Fund (NYSEArca:IYC - News)SPDR S&P Retail ETF (NYSEArca:XRT - News)PowerShares S&P SmallCap Consumer Discretionary (NYSEArca:XLYS - News)Powershares Dynamic Retail Portfolio ETF (NYSEArca:PMR - News)PowerShares Dynamic Leisure & Entertainment Portfolio (NYSEArca:PEJ - News)PowerShares Dynamic Media Portfolio (NYSEArca:PBS - News)PowerShares Dynamic Retail Portfolio (NYSEArca:PMR - News)PowerShares Dynamic Telecommunications & Wireless Portfolio (NYSEArca:PTE - News)International Consumer DiscretionaryGlobal X China Consumer ETF (NYSEArca:CHIQ - News)iShares Global Consumer Discretionary (NYSEArca:RXI - News)Fundamental Consumer DiscretionaryPowerShares Dynamic Consumer Discretionary (NYSEArca:PEZ - News)First Trust Consumer Discretionary AlphaDEX Fund (NYSEArca:FXD - News)Rydex S&P Equal Weight Consumer Discretionary (NYSEArca:RCD - News)Short and Leverage Consumer DiscretionaryProShares Ultra Consumer Goods (NYSEArca:UGE - News)ProShares Ultra Consumer Services (NYSEArca:UCC - News)ProShares UltraShort Consumer Goods (NYSEArca:SZK - News)ProShares UltraShort Consumer Services (NYSEArca:SCC - News)Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds.