Playing The Recovery With Consumer Discretionary

By Aaron Levitt | October 29, 2009 AAA

An interesting thing occurred to me this weekend while visiting my local Target (NYSE: TGT) store: people were shopping. What was striking was the sheer number of shoppers and fullness of their carts. Just as an army marches on, American consumers have continued their spending. Consumer confidence and how willing they are to part with their hard-earned dollars tells a lot about our current economic state.

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Wants vs. Needs
Consumer discretionary companies produce the non-essentials. These products and services, such as automobiles, luxury goods, hotels and entertainment, are often the first things cut when consumer sentiment turns sour and the economy worsens.

The sector is highly cyclical and correlated to the health of the economy. It is often compared in relation to its sister sector, consumer staples (think shampoo) which tend to perform no matter which way the economy is moving.

This is why consumer products giant, Procter & Gamble (NYSE:PG) makes a fine addition to any long-term portfolio. However, when consumer spending returns, discretionary stocks take off, producing short-term returns that outweigh their more conservative staple sisters. Over the past few months, the consumer discretionary segment of the S&P 500 has sharply outperformed the staples subdivision and the general broad S&P 500 index in general.

Getting in On the Ground Floor
While it is too early to tell if the United States economy has truly turned a corner and begun its surge upward back to normalcy, it may make some sense for investors to take a small short or medium-term gamble on the sector. Just how jaded the U.S. consumer really is and full long-term effects of the credit crisis on are the real unknown. But, if the economy takes off these investments will provide a nice return. The best way to do this is through the number of exchange traded funds (ETFs) that focus on the discretionary sector.

The oldest, largest and most heavily traded is the Consumer Discretionary Select Sector SPDR (NYSE:XLY). The fund contains 80 of the biggest consumer brands in the United States including shares of Disney (NYSE:DIS), Nike (NYSE:NKE) and the previously mentioned Target Corp. Overall P/E for the fund's holdings is a reasonable 18.2, which still has some room to run if things move in positive direction. The fund yields 1.54% and charges a rock bottom 0.21% in expenses.

As a broader choice, Vanguard's Consumer Discretionary ETF (NYSE:VCR) follows MSCI U.S. Investable Market Consumer Discretionary index and includes 383 different stocks of varying market cap size. However, 33% of the ETF's assets are its top holdings, which are a mirror image of the Sector SPDR. Investors can think of this ETF as the XLY Plus. Vanguard charges 0.25% in expenses.

Betting Big on Retail
For investors wanting to make a direct bet on the fate of the retailers, SPDR S&P Retail (NYSE:XRT) provides exposure to 63 of the largest retail stores in the nation. While not a "pure" play on consumer discretionary spending as it contains grocery stores such as Kroger (NYSE:KR), it is a play on overall spending.

The retail ETF will experience more volatility than broad-based consumer discretionary ETFs. (To learn more about ETFs for index investing, check out ETFs Vs Index Funds: Quantifying The Differences.)

The Bottom Line
The fate of the U.S. economy lies within the hands of its consumers. As people feel better about their overall situation, they tend to spend more on discretionary items. The proceeding three ETFs offer a short and medium-term play, if and when the economy returns.

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