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I’m a consumer. You’re a consumer. In fact, just about everyone you know is a consumer. But in these tough economic times, we often have to prioritize.
On the other hand, not everyone is closely watching every penny they spend. Some people are making — and spending — more money than ever! So today I’m going to tell you how to use exchange traded funds (ETFs) to take advantage of a recovery in consumer spending.
First, let’s go over the difference between …
Staples and Discretionary Items
Investment analysts make a distinction between spending on necessities vs. spending on “luxuries.” You’ll sometimes hear them talk about consumer staples and consumer discretionary stocks.
What’s the difference? Staples are the things we buy because we don’t have much choice. Items like …
- Medicine
- Diapers
- Food
- Gasoline
Can you do without these? Sometimes, yes, although not for long. And you can also shop around, buying a less expensive brand of diapers instead of the one you see advertised with the cute babies. Nevertheless, most of us have base-level spending that we can’t easily avoid. These are the consumer staples.
Consumer discretionary items are discretionary because no one has to buy them …
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| You can live without a tropical vacation. |
For example, you can do without a vacation to Mexico. You don’t have to eat at fancy restaurants. You can drive a less expensive car or live in an apartment instead of a McMansion. You have discretion over this kind of spending.
There isn’t a firm line between staples and discretionary; one man’s necessity can be another man’s luxury. Yet the categories are useful when looking at consumer-oriented stocks.
Companies in each group tend to track the economic cycle. When the economy is booming, people have more spending power and are more likely to buy discretionary items. Likewise, consumers cut back in tough times and buy only what they must.
A stock like Coach Leatherware (COH), for instance, is highly discretionary. No one has to buy its fancy leather goods. Walgreens (WAG), however, is more of a staple. People frequently go there to buy items they cannot do without, such as medicine.
So it should be no surprise that Coach stock performed very well in the boom years, and not so well when the recession hit. Then Walgreens took its turn in the spotlight.
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| Consumers need their medicines. |
Right now, the consumer discretionary sector is back on an upswing. Hard to believe?
Often the reasons a specific market sector goes up (or down) are apparent only in hindsight. Yet the market is telling us that luxury goods companies are doing much better than they were a year ago.
And one thing I’ve learned over the years is that you have to follow the trend — even when you don’t understand it!
How to Play the Trend …
Obviously we’re in a difficult investment environment. So I certainly don’t blame anyone who chooses to ride out the uncertainty by staying in cash or contrarian niches like gold.
Nonetheless, many people still want to keep at least part of their money in the market. And now might be a good time to look at some consumer-discretionary sector ETFs.
I believe a good sector ETF should be diversified among stocks in its group and liquid — meaning both the ETF and its underlying stocks have good trading volume so you can get in and out whenever you need. But not every ETF fits both these criteria. Even some well-known names fail on one count or the other.
Here are some consumer-discretionary ETFs you may want to consider.
For broad-based sector exposure, look at …
- Vanguard Consumer Discretionary (VCR)
- SPDR Select Sector Consumer Discretionary (XLY)
- iShares S&P Global Consumer Discretionary (RXI)
And to zero in on specific groups within the consumer-discretionary sector, these ETFs are worth checking out …
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| China is the next big consumer market. |
- SPDR S&P Retail (XRT)
- PowerShares Dynamic Leisure & Entertainment (PEJ)
- SPDR S&P Homebuilders (XHB)
Finally, here’s a bonus idea for you. The consumer sector in China is growing fast, and now there is an ETF that follows it: Global X China Consumer ETF (CHIQ).
This last one is speculative, of course, but might pay off big over the long run as China leapfrogs into the 21st Century.
I hope you find some of these ideas useful. Be cautious, and don’t forget that the trend is usually your friend!
Best wishes,
Ron
P.S. Are you following me on Twitter? Check out http://www.twitter.com/ron_rowland for frequent updates, personal insights and observations about the world of ETFs.
If you don’t have a Twitter account, you can sign up today at http://www.twitter.com/signup and then click on the ‘Follow’ button from http://www.twitter.com/ron_rowland to receive updates on either your cell phone or Twitter page.
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