The consumer discretionary sector is not feeling very well this year. Inflation, supply chain issues, lockdowns and the war in Ukraine are pushing companies to cut full-year profitability forecasts as consumer confidence hits new lows.
Although companies in the sector are currently operating in an uncertain environment, now may be the time to buy an entire sector as investor attitudes towards China may change.
Consumer Discretionary ETFs
The best way to bet on an entire sector is to buy an ETF since it is a low risk and low cost investment.
The largest consumer discretionary fund by assets under management is Consumer Discretionary Select Sector SPDR ETF (NYSEARCA:XLY). XLY is an exchange-traded fund that tracks the S&P 500 Consumer Discretionary Index. The fund has over $14.5 billion in assets under management. The fund was launched in December 1998 by one of the leading companies in the global asset management market – State Street Global Advisors. Currently, the fund includes 61 companies.
Chinese Premier Li Keqiang said at a conference with representatives of regional authorities in May that the Chinese economy was facing greater difficulties in some areas than in 2020. As experts suggest, this statement signals that the government’s target of 5.5% Chinese GDP growth in 2022 may be elusive. Retail sales in the country fell 11.1% year-on-year to $440 billion in April, worse than market forecasts, which suggested a 6.1% drop.
Data showed an acceleration in the decline of major indicators of China’s economy in April amid the ongoing lockdown in Shanghai, with a population of around 24 million, since March 28, and with restrictive measures in other regions, notably the capital Beijing. This directly affected production, consumption, logistics, foreign trade and construction.
Nevertheless, Fu Linghui, a spokesman for the Bureau of Statistics, is convinced that the decline is short-term and that the foundations for long-term growth remain.
Premier Li Keqiang urged authorities to work hard to reduce unemployment and boost economic growth in the second quarter. The tone of the Premier Li Keqiang-led conference could herald a wave of coronavirus easing and economic support measures. For example, the Shanghai administration has already announced the start from June 1 of the relief from confinement introduced at the end of March, which affected 25 million inhabitants. The city plans to restore production and life to normal by mid-June. Separately, a spokesperson for China’s Ministry of Commerce, Shu Jueting, said his department will adopt a package of measures to support domestic consumption. Earlier, some regional authorities announced local support measures. For example, authorities in Shenzhen, China’s main tech hub, announced the issuance of e-vouchers and coupons totaling $77 million to the public ahead of Labor Day to support consumer spending and encourage people to do not travel during the holidays.
At the end of May, the Shanghai authorities adopted a package of measures to accelerate economic recovery. In addition to allowing work to resume without the need for special permission, the administration made several decisions on grants and benefits. There are tax deferrals and wage subsidies for businesses involved in catering, retail, tourism, etc., utility cost subsidies for a number of businesses, subsidies for development of the film industry and other creative industries, tourism and sport among the measures taken .
Chinese authorities are also expected to support the auto industry from June by issuing subsidies and tax cuts on car purchases in rural areas. Car sales in China fell 48% year-on-year to 1.18 million units in April, according to the China Association of Automobile Manufacturers.
XLY companies in China
China’s zero-tolerance policy on COVID-19 has affected U.S. consumer discretionary businesses in many ways.
You’re here (TSLA) is the second largest XLY position with a weighting of 17.65% in the portfolio (as of 6/15/22). The company had a terrific first quarter of 2022. Electric vehicle revenue was $16.86 billion, up 87% from the same period in 2021. Gross profit rose a record 32.9% to $5.54 billion of dollars. Revenue growth was driven by an increase in the number of Tesla vehicles delivered and an increase in the average selling price. Electric vehicle unit sales, however, fell 98% in April as Tesla faced lockdowns. In May, the company saw sales rebound as consumer activity in China began to pick up.
Tesla is very sensitive to the situation in China since its sales in the country represent around 18% of total turnover.
In the first quarter, comparable sales of McDonald’s (MCD) (the fund’s third-largest holding) restaurants in China declined (the company did not disclose details) due to partial closures. At the same time, the chain’s management noted that of the 800 new outlet openings planned for the whole of 2022 in China, 250 outlets managed to open in the first quarter, “as planned”, but clarified that due to lockdowns, it may be necessary to revise the schedule for the rest of the year.
Nike (NKE) also has problems in China. In the third financial quarter, which ended February 28, revenue was $10.9 billion (+5% year-on-year). Sales were down in Greater China (-5% YoY). Footwear production is mainly done in Vietnam (51%), Indonesia (24%) and China (21%), while clothing production is done in Vietnam (30%), China (19%), in Cambodia (12%) and Indonesia (less than 12%). COVID-19 outbreaks or other force majeure events in China and other countries that manufacture most products may have hurt Nike’s financial performance.
Greater China accounts for 20% of total Nike sales.
The Chinese market is very important for consumer discretionary companies because it is very large and offers the highest growth rates.
The XLY is down 34% year-to-date, while the S&P 500 is down 22% year-to-date.
Companies in the consumer discretionary sector are facing big problems in the large Chinese market. However, as we can see there are some signs that the situation is improving, and now may be the time to buy the dip, as investors will turn to China and the positive news will quickly lead to a revaluation of these companies by the market.
That said, I believe XLY is a to buy at present.