Will Frugality Weigh On Consumer ETFs?

by on November 9, 2009 | ETFs Mentioned:

The recession may technically be over, but the recession mindset continues to linger in many consumer households, and may impact shopping habits for the foreseeable future. With unemployment recently breaking through the 10% mark, the Federal Reserve noted that household spending “appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit.” A recent article in the Wall Street Journal highlights the impact that this new-found frugality is having on consumer products companies, ranging from simple cost cuts to more complex changes to product development strategies.

McDonald'sMany investors assume that consumer spending habits have a more pronounced impact on consumer discretionary companies, including restaurants, entertainment firms, and retailers of non-essential goods. But the trend towards closely monitoring consumer budgets can also have a big impact on consumer staples firms. “Procter & Gamble Co. and other major makers of household staples, while vowing to resist price wars, say they plan to flood stores with enhanced versions of existing products,” writes Julie Jargon. “After nearly a decade of introducing increasingly expensive items, P&G’s new products will span a wider range of prices, most notably at the low end.”

But there’s a fine line to walk in catering to these frugal consumers: retailers are striving to promote then enhanced value of their products, but striving to avoid all-out price wars that can quickly erode profit margins. Walmart recently cut prices on ten highly anticipated books to $10, and Amazon.com and Target quickly followed suit.

Relative Performance

Not surprisingly, the Consumer Staples Select Sector SPDR Fund (XLP), has outperformed the Consumer Discretionary Select Sector SPDR Fund (XLY) by a wide margin since September 2007, but the discretionary fund has been gaining ground in 2009 as some consumers have returned to their old ways:

Consumer ETFs

Consumer discretionary stocks may seem like a timely investment decision at this point, but the lag that this sector will likely experience as the economy continues its recovery should also be taken into consideration. Many companies are aggressively engaging in promotions to make their products attractive to shoppers on a strict budget, and this pattern that could continue until well after the economy begins consistently growing again.

Disclosure: No positions at time of writing.