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ETF Investors React With Caution To A Weakening Consumer

Last week, board members of the Federal Reserve signaled that they may begin hiking overnight lending rates as early as 2015.  A majority of analysts believe that the message is in line with an anticipated acceleration of U.S. economic growth and a more robust expansion. Similarly, economists polled by the National Association for Business Economics (NABE) foresee a 2.6% bounce in consumer spending here in 2014.

If we’re going to spend more, however, wouldn’t our paychecks need to grow at a faster clip? Wage growth of 0.5% in 2013 compares rather poorly to the near 3% growth from 2012. Additionally, the evidence for wage growth to stage a monster rebound in 2014 is skimpy.

Rock bottom interest rates and falling commodity prices in previous years may have offset a lack of purchasing power. Unfortunately, recent drought woes have sent food costs skyrocketing. Corporations will find it challenging to pass along higher commodity prices to consumers, hurting the prospects for SPDR Select Sector Consumer Staples (XLP). Meanwhile, stagnant paychecks rattled by food and energy inflation might hinder discretionary consumption. An ETF enthusiast should be wary of companies represented by SPDR Select Sector Consumer Discretionary (XLY).

XLY 50 200

In spite of recent weakness in health care due to massive profit-taking in the biotechnology arena, investors have been questioning the so-called “resilience of the consumer.” Consumer-oriented stocks are weaker than all other stocks over the prior 3 months.

If the Consumer Represents 70% of The Economy, Then…
3 Months %
Select Sector Utilities (XLU) 9.2%
Select Sector Basic Materials (XLB) 5.3%
Select Sector Health Care (XLV) 5.2%
Select Sector Technology (XLK) 4.5%
Select Sector Financials (XLF) 4.2%
SPDR Select S&P 500 (SPY) 3.0%
Select Sector Industrials (XLI) 1.4%
Select Sector Energy (XLE) 1.0%
Select Sector Consumer Staples (XLP) 0.7%
Select Sector Consumer Discretionary (XLY) -0.5%

The stock market is not the only forward-looking creature that is showing trepidation with regard to the consumer. In the bond market, the yield curve is flatter than at any point since early in the current recovery (October 2009). Some feel that an exodus from shorter-term bonds and a desire for longer-term ones merely represents portfolio rebalancing as a response to Federal Reserve guidance on eventual rate hikes. Less discussed, however, is the notion that investors crave longer-term treasuries when they are fearful of economic uncertainty.

Looked at another way, when ETF traders express confidence that rates will rise alongside a strong economy, they typically short U.S. Treasury bonds via ProShares UltraShort 20+ Year (TBT). Yet the “TBT trade” has not looked this anemic since bond investors put Fed tapering worries to bed last August. Treasury bonds as an asset class have actually trended higher since the end of August.

TBT at a nine month low

The bottom line is that consumer stocks may weigh on other stock segments in the months ahead. The bond market certainly thinks so. Vanguard Extended Duration Treasury Bond (EDV) is gaining momentum by the day.

edv 9 months

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