In a Brittle Economy, the American Consumer Remains King
In this series of Newsletters, we have covered different investment strategies using a spectrum of instruments, for example, directional as well as hedging strategies with options, currency tilts with ETFs and ADRs, and safer investments in TIPS as safe haven for the high degree of uncertainty prevailing today.
We now look at the fundamentals of the principal global economic driver: the American Consumer. To put it in context, the US economy is about 25.5% of the World’s economy, and consumption represents 67.5% of the country’s GDP, according to the United Nations. Meaning, of every $10 of economic activity in the world, the American consumer generates $1.70.
Data sourced from United Nations, 2020
All of which is to say that the American consumer takes up a big chunk of the World’s manufacturing – from sneakers to heavy machinery to orange juice.
Despite the spike in inflation and the lingering risk of recession, the American consumer remains solid. Year-over-year consumption continues growing – albeit at a smaller pace – fueled by a combination of government subsidies, inflation-adjustments to social security payments, and a solid employment market with associated wage increases. Moreover, considering the robust performance of the US$ vs foreign currencies, the US$ cost of imported goods is likely to drop as we go into the last few months of the year – just in time for the peak retail season between Black Friday and Christmas.
Exposure to the American Consumer – ETF v Stocks
As we have discussed previously, investors have an option of gaining a wider, thematic exposure to the American consumer by choosing sector ETFs or selecting individual stocks for a more direct and selective exposure to the sector.
Retail-themed exchange traded funds (ETFs) with large market cap and an active and liquid market include VCR (Consumer Discretionary, Vanguard), IYK (US Consumer Staples, Blackrock’s iShares), and XRT (SPDR S&P Retail, State Street). Some of the main benefits of gaining exposure to the sector through ETFs are (i) simplicity, as investors that are attracted to the secular trend benefiting the retail sector skip the need to select individual stocks based on valuation, catalysts, etc.; and (ii) diversification, as investors avoid the risk of negative catalysts specific to a single name. To see a broader list of retail-themed ETF’s go to State Street Global Advisors or iShares.
Conversely, investors that want to narrow their selection to specific stocks could select from a list of the larger retail names listed in the S&P500.
The three largest importers in the US, which are benefiting from lower inventory costs as the dollar gains, are:
What could go wrong with this type of strategy?
This sector-specific selection has both a risk of underperforming the wider equity market, as well as a risk of further selling off in stocks in general. The sector-specific underperformance could be triggered by a number of catalysts – from an inflection in the positive wage and employment trends, to a rebound in inflation eroding the consumer’s purchasing power. Simultaneously, the non-diversifiable risk of a continuing bear market remains. More hawkish signaling from the Fed, including rising rates, as well as more dramatic-than-expected economic slowdown, could pull the general market down dragging the retail sector with it.
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