2024-01-16 06:59:08 ET
Summary
- The US economy and retailers performed well in 2023, defying predictions of a recession in the retail sector.
- VanEck Retail ETF is a market-cap weighted ETF that focuses on the top 25 retail giants, with Amazon as its most prominent holding.
- The US economy is expected to be more robust in 2024, which could benefit the retail sector and RTH's performance.
Who would've guessed? 2023 kicked off with a cloud of gloom hovering over the economy. Pundits were predicting a recession that could hit the retail sector hard. The narrative was set: consumers tightening belts, retailers wilting under the harsh sun of inflation and soaring borrowing costs. But the year turned out to be a surprise blockbuster, defying dire predictions.
This was evident in the performance of the VanEck Retail ETF ( RTH ), offering investors exposure to the 25 biggest US-listed retail players. As we peer into 2024, the economic landscape looks promising, hinting at a potential uptick in consumer spending. That spells good news for the VanEck Retail ETF, making it a shining star in the investment universe. Keep an eye on this ETF – it's a story worth following.
RTH: A Market-Cap-Weighted ETF
The VanEck Retail ETF, or RTH, offers investors a slice of the world's retail heavyweights. This ETF tracks the MVIS US Listed Retail 25 Index, a market-cap weighted index featuring the largest retailers on the US stock market. RTH strategically focuses on an industry increasingly dominated by online retailers who cater to a global audience, from Canada to India. These retail titans have transcended geographical boundaries, serving customers worldwide and generating sales from diverse locations. Amazon ( AMZN ) stands out as RTH's most prominent holding, exemplifying this global retail reach.
Before delving into the details of RTH’s portfolio, let's consider its size and cost-efficiency. With assets under management totalling $174.8 million, RTH is a moderately sized ETF concentrated on a specific segment within the consumer discretionary sector. In comparison, the SPDR S&P Retail ETF ( XRT ), a major player in retail-focused ETFs, manages nearly $480 million in assets.
RTH's expense ratio stands at 0.35%, translating to an annual fee of $35 on every $10,000 invested — a competitive rate in the ETF landscape. This fee is below the median ratio of 0.49% for the ETF universe, as per data from Seeking Alpha. Additionally, RTH has earned a robust 'B' grade from Seeking Alpha’s ETF Grades, indicating its healthy standing. Notably, its counterpart, the XRT ETF, shares an identical expense ratio of 0.35%.
The key distinction between RTH and XRT lies in their portfolio construction strategies. RTH adopts a market-cap weighted approach , centering on the top 25 retail giants, whereas XRT employs a modified equal weighting scheme across its more expansive portfolio of 76 holdings. Each company in XRT’s portfolio is allocated an equal weight of approximately 1.3% upon portfolio rebalancing. In contrast, in RTH’s structure, Amazon alone constitutes just over 20% of the portfolio’s weight. The top five companies in RTH – Amazon, Home Depot ( HD ), Costco Wholesale ( COST ), Walmart ( WMT ), and Lowe's Companies ( LOW ) – collectively represent over half of its total portfolio weight.
This difference in strategy highlights RTH’s inclination towards a few prominent players, particularly Amazon, while XRT offers an equal-weighted representation of the retail sector, without any bias towards a single company. The choice between these ETFs depends largely on the investor's goals and existing portfolio composition.
For those seeking comprehensive coverage of the retail sector, including smaller, potentially dynamic companies, or for investors who already hold shares in large retailers like Amazon and Walmart and are looking to diversify, XRT emerges as a more suitable option.
However, for investors aiming for a representation of the retail industry that aligns more closely with the market dynamics, RTH might be the preferable choice. This is because the retail market itself is heavily influenced by larger players. For instance, Sally Beauty Holdings ( SBH ), a smaller specialty retailer, does not have the same market impact as Walmart, yet it receives equal representation in XRT's equal-weighted structure. This difference in approach highlights RTH's alignment with market’s realities, as opposed to XRT's equal distribution across a range of retailers.
Moreover, RTH offers a distinct advantage for investors seeking stability, as it focuses on well-established, large-cap companies with decades of operational history and substantial financial resources. These larger retailers are typically better equipped to navigate market uncertainties and economic cycles compared to smaller, riskier retail firms. Small retailers often carry a higher risk profile due to their limited resources and susceptibility to market fluctuations. This risk can influence an equal-weighted portfolio like XRT. In contrast, market-cap weighted ETFs like RTH avoid such exposures by concentrating on these more established and financially robust companies.
Beating Expectations
The year 2023 proved to be unexpectedly favourable for retailers, despite initial headwinds from high interest rates and inflation. At the beginning of the year, amidst the Federal Reserve's historic rate hikes and headline inflation above 5%, analysts anticipated a potential recession impacting consumers and businesses. However, the US economy and its consumers demonstrated impressive resilience, far outpacing expectations.
The year saw steady GDP growth, with a 2.2% increase in the first quarter, 2.1% in the second, and an impressive 4.9% in the third. Retail sales, although slightly tempered compared to the previous year, largely rose throughout 2023. This upward trend was exemplified in November's retail figures, where sales grew by 0.3% month-over-month, surpassing forecasts of a 0.1% decline. Year-over-year, retail sales in November climbed 4.1%, a slight decrease from the 6% growth in the previous year, yet still remarkable considering the prevailing economic conditions of high interest rates and inflation.
Reflecting this sectoral strength, RTH delivered robust returns of 20% over the year. Key holdings like Amazon not only expanded revenues and earnings but also improved profit margins. Despite the challenges of inflation and high interest rates, Amazon's operating margins in the third quarter rose significantly to 7.8%, nearly reaching historical highs of 8.2%, as cost-cutting measures took effect. Amazon, along with other top RTH holdings such as Home Depot and Walmart, consistently outperformed analysts' earnings predictions throughout 2023, underscoring the ETF's solid performance and the broader resilience of the US retail sector.
Looking Ahead
As we step into 2024, the US economy appears more robust, which spells good news for the retail sector and, by extension, for RTH's performance. As I discussed in my previous article , there's a strong likelihood that the Federal Reserve will dial back interest rates this year. The CME FedWatch Tool indicates that about 80% of traders anticipate a rate cut after the Fed's March meeting. Lower interest rates could invigorate the retail sector by easing borrowing costs for both businesses and consumers.
The labor market remains solid, as evidenced by the addition of 216,000 jobs in December and a 4% annual wage growth, with the unemployment rate holding steady at a favorable 3.7%. While the monthly job creation average in 2023, at around 225,000, was lower than 2022’s remarkable average of 399,000, it still stands strong compared to pre-pandemic levels. It’s worth noting that 2022 represented an exceptional period for the labor market, ranking as the second-best year in its history.
Inflation, which has been a major concern, shows signs of easing. The headline Personal Consumption Expenditures [PCE] index rose by only 2.6% year-over-year in November, and the core PCE, which excludes volatile food and energy prices, increased by 3.2%. These figures are notably lower than the near 5.5% and 5% rates seen at the beginning of the year, respectively.
Consequently, consumer sentiment is also on the upswing. December's consumer sentiment index from the University of Michigan improved to 69.7, up from 61.3 in November and 59.8 from a year earlier. While still below the pre-pandemic highs in the 90s, this metric shows a promising upward trend compared to the annual average of 59 last year.
This confluence of factors – healthier job market, rising wages, controlled inflation, and anticipated interest rate cuts – should favorably impact the retail sector. I expect that retail sales will continue their upward trajectory in 2024. Top RTH holdings like Amazon and Walmart are likely to experience sales growth. With potential reductions in borrowing costs and ongoing efforts to streamline operations and cut costs, we can anticipate an improvement in these companies' profit margins.
Wall Street's optimism for the retail sector in 2024 is evident. According to Bloomberg, analysts have boosted their net profit forecasts for Amazon by 18% over the past three months. Seeking Alpha data further corroborates this trend, showing that Amazon's earnings per share ((EPS)) expectations for 2024 have been revised upward 38 times in the last 90 days.
It's important to note that Amazon's influence extends beyond retail. The growth prospects for its AWS segment and the potential long-term impact of AI advancements are likely contributing to these positive reassessments. Nevertheless, Amazon's retail prowess remains a critical factor, particularly for RTH, where Amazon wields considerable influence due to its large portfolio weight. Other top holdings in RTH, like Costco and Walmart, have also seen upward earnings estimate revisions, as per Seeking Alpha data, suggesting a broader positive shift in the retail sector's outlook. This reinforces my bullish stance on RTH, and I anticipate the ETF will continue its upward trajectory.
Takeaway
In 2023, the US economy exceeded expectations and shows promise for continued success. Most economic indicators now suggest a more favorable position compared to a year ago. This optimistic outlook could be a boon for the retail sector, potentially lifting the performance of the VanEck Retail ETF, which provides exposure to leading retailers, notably Amazon, its largest holding. As the Federal Reserve considers reducing interest rates in 2024, combined with a trend of falling inflation, there's potential for consumer spending on goods to rise, which could boost the earnings of RTH's holdings. The ETF has already seen an 8% increase in the last six months, and this positive momentum could be sustained moving forward.
However, when it comes to valuation, RTH presents a mixed picture. The lofty valuations of its underlying holdings, particularly its top-10 stocks which make up 72% of the portfolio weight, are a concern. Most of these stocks trade at multiples significantly higher than the sector median, as per Seeking Alpha data. Amazon, for instance, constitutes about a fifth of RTH's assets and trades at over 50 times forward earnings estimates, earning a ‘ D- ‘ valuation grade from Seeking Alpha. This pattern of high valuation grades extends to other major holdings within RTH. Consequently, value-focused investors might want to consider this ETF during market dips or periods of weakness.
However, it's crucial to acknowledge potential risks. While my optimistic view hinges on the expectation of a strong economy in 2024, there are notable headwinds to consider, especially concerning the delayed impact of high interest rates. There's a viewpoint suggesting that the economy's impressive performance in 2023 may partly be due to the lag in fully realizing the effects of elevated interest rates. These effects might not have manifested fully last year, but could become more pronounced in 2024. Should the lingering impact of these rate hikes begin to significantly affect business earnings and consumer spending, it could negatively influence the retail sector's performance. Consequently, such a scenario might also place downward pressure on the RTH ETF.
For further details see:
VanEck Retail ETF Shines In The Brightening Economic Sky