The Right Way to Revisit Retail

With all the talk about consumers being flush with cash courtesy of Uncle Sam and many non-essential consumer segments of the economy reopening, it stands to the reason that the consumer discretionary sector is performing admirably this year.

It is. The S&P 500 Consumer Discretionary Index is up 9.49%, though that trails the 12.09% returned by the S&P 500. Much of that “laggard” status is attributable to (NASDAQ:AMZN). The e-commerce giant is 23% of the consumer cyclical index, but it's up just 1.52% year-to-date.

Speaking of Amazon, it's reasonable to say advisors and their clients have, at some point, received a package with the ubiquitous smiley face. And there's a really strong chance that, during the coronavirus pandemic, advisors and clients engaged in some form of online retail that they otherwise would not have. That is to say, COVID-19 caused myriad disruptions across sectors and many of those changes will be permanent. 

So the conversation for advisors to have with clients, particularly the younger ones that are risk-tolerant and have long roads to retirement, is framing consumer cyclical exposure for a new retail world order.

A Chat Worth Having

This is a conversation worth engaging in because data confirm advisors are deploying more sector-specific strategies and clients generally like that tactical exposure. Specific to consumer cyclical, this level of advisor engagement takes on added relevance due to the sector's stellar long-term track record.

“From 12/31/2010 through 3/31/2021, the S&P 500 Consumer Discretionary has rewarded investors, generating annualized market returns of around 18% compared to the S&P 500’s returns of just above 14%,” according to ProShares research.

Over that period, the sector evolved in dramatic fashion. Today, the S&P 500 Consumer Discretionary Index allocates nearly a quarter of its weight to internet retail – the place clients should want to be in the retail space – though most of that exposure comes by way of Amazon. Point is, traditional consumer cyclical strategies may not only leave clients disappointed, but leave them exposed to some challenged industries.

“The next three largest industries account for 51% of the Consumer Discretionary sector: Hotels, Restaurants & Leisure; Specialty Retail; and Automobiles,” notes ProShares. “As a result, an investment in Consumer Discretionary is more sensitive to the performance of these three segments combined than that of Internet Retail.”

All In Online?

Investors are often set in their ways and it's on advisors to open clients' eyes to new opportunities. While that low-fee consumer cyclical ETF or index fund appears attractive due to its big Amazon weight and puny expense ratio, investors are making a potentially dangerous trade-off by not having more substantial online retail exposure.

Translation: Clients wanting real growth with their consumer discretionary exposure should want more online retail.

“These dynamics put a spotlight on a discrepancy between different components within the Consumer Discretionary sector that had been years in the making,” notes ProShares. “Since the end of 2010, the Internet Retail component of Consumer Discretionary pulled away from the rest of the sector with regard to sales and profitability. Sales grew almost eight times faster than that of the next-fastest-growing discretionary segment, S&P 500 Household Durables.”

Those are impressive rates of earnings and sales growth and they're unlikely to be found with other consumer discretionary mega caps, such as Home Depot (NYSE:HD) and McDonald's (NYSE:MCD). That growth is almost certainly unattainable with any number ailing brick-and-mortar retails that populate standard consumer discretionary strategies.

By focusing the consumer cyclical conversation on e-commerce, advisors can gain a potential twofold benefit: Displaying value to clients while perhaps boosting portfolio performance.

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