Studying stock market sectors can tell us a lot about what's driving broader indexes higher or holding them back. And if you're more focused on individual stocks, it can give you clues where to look.
A prime example today is the consumer discretionary sector. Consumer discretionary is the only one of the market's 11 sectors that's down this year, but I think there are good reasons for long-term investors to expect a turnaround. There are plenty of low-cost exchange-traded funds (ETFs) that mirror the composition of a given sector, and the Vanguard Consumer Discretionary ETF (VCR 1.27%) is a great way to invest in this one.
Here's why the consumer discretionary sector is underperforming the broader indexes and how to use ETFs to achieve diversification in the stock market.
Image source: Getty Images.
Not your typical ETF
Consumer discretionary covers a wide variety of consumer-focused industries like retail, automobile, home improvement, restaurants, resorts, and cruise lines. These are the things most consumers buy after they've covered their basic needs like food and personal care products (which fall under consumer staples).
It's a unique sector for a variety of reasons. If you take a look at the holdings of the Vanguard Consumer Discretionary ETF, what immediately jumps out is the 23.4% weighting in Amazon (AMZN 1.86%) and the 10.6% weighting in Tesla (TSLA 4.09%).
NYSEMKT: VCR
Key Data Points
Amazon is in the sector due to its focus on e-commerce and retail. But it's no secret that Amazon Web Services is arguably the most valuable aspect of Amazon today. The company would probably be a better fit in the technology sector, given its focus on cloud infrastructure.
Tesla is in a similar boat. Tesla is increasingly focused less on electric vehicles and more on robotics and artificial intelligence. And even Tesla CEO Elon Musk told investors that if they don't believe in the widespread adoption of the company's Full Self Driving technology stack, then they should not hold the stock. So there's also a case that Tesla could be in the technology sector.
Here's a full rundown of the industries covered by the Vanguard Consumer Discretionary ETF:
|
Industry |
Weighting |
|---|---|
|
Broadline retail |
26.1% |
|
Automobile manufactures |
13.2% |
|
Restaurants |
10.8% |
|
Home improvement retail |
9.2% |
|
Hotels, resorts, and cruise lines |
8.8% |
|
Apparel retail |
4.7% |
|
Homebuilding |
4.3% |
|
Automotive retail |
4% |
|
Footwear |
2.8% |
|
Other specialty retail |
2.3% |
|
Automotive parts and equipment |
2.2% |
|
Casinos and gaming |
2.2% |
|
Apparel, accessories, and luxury goods |
2% |
|
Leisure products |
1.1% |
|
Education services |
1% |
|
Distributors |
0.9% |
|
Specialized consumer services |
0.7% |
|
Home furnishing retail |
0.7% |
|
Consumer electronics |
0.6% |
|
Computer and electronics retail |
0.6% |
|
Leisure facilities |
0.6% |
|
Home furnishings |
0.5% |
|
Household appliances |
0.3% |
|
Housewares and specialties |
0.1% |
|
Motorcycle manufacturers |
0.1% |
|
Tires and rubber |
0.1% |
Data source: Vanguard.
Other sectors may be heavily concentrated in just a few industries. For example, the tech sector is essentially divided into hardware and software. Financials mostly include big banks, regional banks, credit card companies, insurance companies, and asset management companies. So the consumer discretionary sector's diversification across so many industries is a unique characteristic.
However, many of these industries can be highly correlated to the broader economy.
Consumer spending is not driving economic growth
The consumer discretionary sector hasn't been participating in the broader stock market rally for a painfully simple reason -- economic growth is driven by corporate spending, not consumer spending.
Big tech companies are investing billions of dollars in Nvidia chips. Increased energy demand to support economic growth and the computing power needed to run complex artificial intelligence models could benefit pipeline and energy infrastructure companies and utilities.
Consumers are less likely to cut spending on household staples made by Procter & Gamble (PG +1.19%) or beverage brands owned by Coca-Cola (KO +0.98%) in the same way as they would delay a big-ticket purchase like a new car or a home. And sure enough, P&G and Coke are both hovering around all-time highs.
It's hard to know exactly when consumer spending will pick up again. But there are some useful economic indicators that provide clues into the health of the consumer.
US Credit Card Debt data by YCharts
As you can see in the chart, U.S. credit card debt initially fell during the worst of the COVID-19 pandemic but has since spiked -- indicating consumers are buying goods and services they can't afford.
Thirty-year mortgage interest rates are down from their highs close to 8%, but are still elevated from 10-year averages.
The Case-Shiller Home Price Index is a benchmark for the cost of the average single-family home in the U.S. The index shot up in 2020 and 2021 and has slowed its growth rate but is still increasing.
The U.S. fixed housing affordability index -- one of my personal favorite economic indicators -- tracks the relative affordability of a 30-year mortgage, assuming a 20% down payment. A level above 100 indicates that the typical family can afford the monthly payment on a loan for a typical home. But a level below 100 indicates that this typical loan is unaffordable.
Pre-pandemic, the metric was hovering around 150 -- give or take. Today, it is at just 93.3. High credit card debt paired with relatively unaffordable housing has been bad news for the consumer discretionary sector.
Declines in consumer spending impact everything from home improvement to vacation spending to spending on high-end apparel (just ask Lululemon, which is down 50% year to date). However, if the Federal Reserve eventually lowers interest rates, we could see consumer health improve over time.
Consumer discretionary stocks are a good value
It's important to understand the external factors that can influence the performance of a stock market sector or an individual company. For example, Home Depot (HD +0.11%) is a very well-run industry-leading company. It can't control the housing market or the consumer's health, but it can take steps to maintain financial health and position the business to endure slowdowns.
At a price-to-earnings ratio of 27.7 , the Vanguard consumer discretionary ETF isn't terribly expensive, given that the valuation is inflated due to the high concentration in Amazon and Tesla. Take those companies out, and you're looking at a bargain-bin P/E ratio of just 18.74 for the sector.
The sector is out of favor for all the right reasons, and there are simply too many good companies at multiyear lows to be too pessimistic about the sector at this point. I have high hopes for the consumer discretionary sector going forward, and the Vanguard Consumer Discretionary ETF provides a great starting point for dipping your toes in the sector. However, the best approach could be to do some additional research and find the brands that you are most confident in, and invest in individual stocks paired with the ETF.
