VCR - VCR: Failing To Justify Its Year To Date Surge

2023-07-25 14:37:36 ET

Summary

• Key indicators suggest that the Vanguard Consumer Discretionary Index Fund ETF Shares year to date surge was premature.
• Although market-based variables imply that cyclical stocks are set to outperform, we think the VCR ETF's strong year to date performance is unwarranted.
• Vanguard Consumer Discretionary Index Fund ETF Shares portfolio managers provide solid long-term risk-adjusted returns. However, that alone is unlikely to substantiate its year to date returns.
• Our methodology for cyclical investing in today's market is to cherry-pick stocks instead of investing in the VCR ETF, which we believe is overbought.

Don't get me wrong, the Vanguard Consumer Discretionary Index Fund ETF Shares (VCR) year to date performance is brilliant for its investors and conveys confidence in the global financial markets, which is beneficial to us all. However, its strong performance does not make theoretical or practical sense to us, meaning it is possibly overbought. As such, the question becomes: is Vanguard Consumer Discretionary Index Fund ETF Shares momentum sustainable, or is it set for a retracement?

Let's observe a few indicators to contribute to the central question.

Characterizing The VCR ETF

Approximately 97.24% of VCR's portfolio spans consumer discretionary stocks, including the likes of Amazon ( AMZN ), Tesla ( TSLA ), The Home Depot ( HD ), and Booking Holdings ( BKNG ).

What does the aforementioned mean? It means that this is a cyclical ETF with exposure to stocks inextricably linked to the economic cycle. Although our Seeking Alpha analysis column shows that we are bullish on some of the ETF's holdings, VCR's portfolio contains 311 stocks , meaning its style-based risk attribution by far outweighs its stock-specific risk. Thus, we believe the ETF is best assessed from a style-based point of view instead of a stock-specific vantage point.

Why A Cyclical Stock Surge Doesn't Make Sense

I know that theory is sometimes unreliable, as it provides a sense of overconfidence when predicting future results. Nevertheless, cyclical financial market behavior of diversified portfolios is quite well explained by theory. Therefore, I'm falling back on my theoretical knowledge to explain why VCR's year to date performance makes little sense.

Firstly, stock market-based theory implies that cyclical stocks tend to underperform safer assets from the peak of an economic cycle through to the bottom. As things stand, factors such as the U.S.'s inverted yield curve, high nominal interest rates, disinflation, and high real interest rates all imply that the market (and the economy) should theoretically be tapering from its peak and into a bottom. However, the behavior of cyclical assets since the turn of the year has contradicted financial theory, which suggests to us one of two things: 1) the market has held weak efficiency; or 2) the market has experienced a bear market surge.

Sub-Indicators

A look at sub-indicators such as consumer sentiment and credit risk tells the same story as the market's salient variables. If you told me that a cyclical stock surge is nearing, I would believe you, as the variables as starting to align toward an improved economic (and cyclical stock) outlook. However, the year to date data suggests otherwise, as the retrospective numbers describe a flimsy environment, contributing to the question of why cyclical stocks have outperformed since the turn of the year.

As already mentioned, consumer sentiment within the U.S. is starting to align. However, past data is grim; consumer utility to save was high, and spending was low (this has also been revealed by disinflation ).

Cyclical stocks tend to perform better when credit risk is low. CDS values have retreated in recent weeks, suggesting an enhanced coincidental and forward-looking market environment. However, credit risk premiums (CDS Values) rose between January and May, leaving me a little confused about the rise in cyclical stocks during that period. As such, contributing to the possibility that VCR might be overbought.

Assessing VCR ETF's Portfolio Management Attributes

An idiosyncratic analysis of VCR substantiates why it might outperform the broader stock market in the long term. For example, the ETF has an information ratio of 0.18 and an active return of 1.47%, suggesting its portfolio managers provide solid risk-adjusted returns, especially if compared to the SDPR S&P 500 ETF Trust (NYSEARCA: SPY ). However, these factors alone do not explain why the ETF surged during a period when its salient indicators were bearish.

Lastly, an observation of the VCR's dividend scorecard doesn't provide much to cheer about from our side. In fact, we believe the ETF's dividend profile is slightly undesirable, meaning the majority of its returns will likely flow from capital gains instead of income.

Final Word - Tabling Our Argument

What I attempted to communicate with today's analysis is our belief that the Vanguard Consumer Discretionary Index Fund ETF might have experienced a premature year-to-date surge. In our view, key indicators suggest the ETF is aligned for future price gains; however, its realized year-to-performance leaves us worried that it might shed short-term value before traversing into a renewed bull run. As such, we assign a neutral weight to the asset and urge investors to consider the fact that the ETF might be overbought.

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