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.

IN PICTURES: Digging Out Of Debt In 8 Steps

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.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Mutual Funds & ETFs

    Buying Vanguard Mutual Funds Vs. ETFs

    Learn about the differences between Vanguard's mutual fund and ETF products, and discover which may be more appropriate for investors.
  4. Mutual Funds & ETFs

    ETFs Vs. Mutual Funds: Choosing For Your Retirement

    Learn about the difference between using mutual funds versus ETFs for retirement, including which investment strategies and goals are best served by each.
  5. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  6. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  7. Mutual Funds & ETFs

    Best 3 Vanguard Funds that Track the Top 500 Companies

    Discover the three Vanguard funds tracking the S&P 500 Index, and learn about the characteristics and historical statistics of these funds.
  8. Forex Fundamentals

    How to Buy Chinese Yuan

    Discover the different options that are available to investors who want to obtain exposure to the Chinese yuan, including ETFs and ETNs.
  9. Mutual Funds & ETFs

    ETF Fees: Why BlackRock is the Latest to Cut Them

    Low expense ratios are a big selling point for ETFs, but are they being focused on too much?
  10. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>

You May Also Like

Trading Center