2023-03-31 00:48:09 ET
Summary
- IYC is iShares' ETF for gaining direct exposure toward the Consumer Discretionary sector.
- Earnings multiples and growth metrics for the Consumer Discretionary sector suggest a fair valuation.
- Compared to its biggest rival, SPDR's XLY, IYC seems to lack in performance.
Thesis
Consumers across the United States consumers had a pretty rough year in 2022, as soaring prices together with rising energy costs, cultivated broader economic uncertainty in the markets. Periods of elevated volatility and selling pressures, however, can often be exploited as an opportunity to gain exposure in hurting sectors with a good long-term outlook, at inexpensive prices.
The iShares U.S. Consumer Discretionary Sector ETF ( IYC ) aims to track sector performance, while being often viewed as an alternative to the more popular SPDR XLY ETF. In this analysis, I explore the Consumer Discretionary sector's current outlook and valuation, as well as the fund's performance and overall attractiveness.
The IYC ETF invests in a diverse range of companies in the consumer discretionary sector, including retailers, media companies, leisure and entertainment companies, and consumer service firms. Some of the top holdings in the fund include Amazon (AMZN), Home Depot (HD), Walt Disney (DIS), and McDonald's (MCD). IYC charges a rather high expense ratio of 0.39% and was incepted in June 12, 2000.
Longer-Term Performance
Over the past decade IYC has recorded a total return of 183% and a CAGR of 11.1% compared to the S&P 500's 183% total 203% return and 11.84% CAGR, including dividend reinvestment. The S&P 500's outperformance, in fact, is attributable mostly to its larger dividend yield, as in terms of price returns IYC actually overperforms the index. As expected for a sector carrying a beta greater than one, IYC exhibits more volatility over the same time period. The S&P 500 also carries a marginally higher Sharpe ratio. Overall, 10Y returns are a bit underwhelming for a more cyclical, higher-growth sector that the fund represents.
Sector Prospects and Valuation
The consumer discretionary sector is cyclical in nature and is expected to outperform the broader market in periods of economic growth, while lacking in performance during rough economic times. The sector, more than any other arguably, is dependent on consumer spending, and as such, consumer confidence defines its outlook.
The consumer sentiment indicator, is a popular measure of consumer confidence, dating back over 40 years. Recessionary periods have historically coincided with low points for the indicator, although its predictive power is not particularly strong. Currently, the indicator is sitting at near 30-year lows, signaling a significant deterioration in consumer spending to come. Over the past couple of months, however, the indicator appears to be bouncing back, making investors less pessimistic for the short- and mid-term.
A more bullish view for sector performance can be extracted when checking another well-known indicator, Inventory-to-sales ratio for retailers. Often considered a more leading indicator, Inventory-to-sales ratios tend to peak at the top of an expansion, signaling an economic downturn to follow. Currently, the ratio is bouncing back from multi year lows, indicating strong demand that retailers struggle to keep up with. When it comes to jumping to a bullish outlook based on a low ratio value, however, we should consider the apparent distortion to the indicator's predictive value that the ongoing supply chain disruptions bring.
In the recently published Guide to Markets by J.P. Morgan Asset Management, a sector valuation outlook is available, as shown in the slide provided below. As of March 2023,the Consumer Discretionary sector trades at an average 20.8x forward P/E compared to its long-term average of 19.2x. That is also compared to an S&P 500 16.7x P/E (15.5x 20-year average). The sector matched the S&P 500's buyback yield, while lacking somewhat in terms of dividend yield. Given that the sector's earnings growth surpasses the broader market it appears as Consumer Dictionaries are more or less fairly valued at this time.
IYC vs XLY vs S&P 500
State Street's Select Sector ETFs are by far the most popular funds investors use to gain targeted sector exposure at low costs. The Consumer Discretionary sector is tracked by the ( XLY ) ETF. The fund charges a 0.10% expense ratio and currently has around $13.6B of Assets Under Management.
Immediately, it becomes clear that XLY is far less expensive than IYC (0.39% expense ratio). This difference in expense ratios is likely to severely affect performance over extended period of time.
In terms of holdings, both funds maintain a very similar companies' mix as their top 10 holdings, with XLY, however, allocating more weighting towards its larger names (Amazon, Tesla, Home Depot and others) and therefore being more concentrated.
As suspected, long-term risk and return performance metrics favor XLY over IYC. The backtest I run using the tools offered by Portfolio Visualizer, dating back to mid 200 reveal that XLY has recorded a 20+ year 9.26% CAGR over IYC's 7.46%. As shown in the table below, XLY also provided superior risk-adjusted returns, as measured both by the Sharpe and Sortino ratios. Volatility, as measured by standard deviation is one area where IYC outshines its rival. Both funds, beat the S&P 500's performance over the same time period, as measured by the SPY ETF.
Especially for investors interested to maybe trade more often, rather than establish a long-term buy and hold strategy, it is important to note that XLY ,due to its larger volume, will be arguably the more suitable option between the two ETFs.
Final Thoughts
After all things are considered, while sector valuation metrics are more or less favorable, the current macroeconomic environment signals that more uncertainty is likely going forward. The Consumer Discretionary sector, is arguably a higher-risk-higher-reward play at this time, contingent on the broader inflation moderation policy to succeed.
IYC represents a trusted solution for investors looking to track the sector. However, after a comparison of the fund to its biggest rival, SPDR's XLY is studied, it becomes evident that the latter represents a more optimal investment choice. For these reasons, I would currently rate IYC as a hold.
For further details see:
IYC: Is The Alternative Consumer Discretionary ETF Attractive?