The economy is growing at a modest pace and the consumer discretionary sector is heading well, with growth projected for the remainder of the year. This is because a strengthening economy and better job prospects are supportive of economically sensitive sectors like consumer discretionary, which typically perform well in a maturing economic cycle.

Below we discuss some strong reasons for investing in consumer discretionary ETFs now.

Encouraging Industry Trends

Consumer discretionary has been the best performing sector from a year-to-date look. Notably, the ultra-popular Consumer Discretionary Select Sector SPDR Fund (XLY - ETF report), which tracks the Consumer Discretionary Select Sector Index, is up modestly 0.7%. After all, cheap fuel and rising income are leading to fatty wallets, which along with an improving U.S. economy, better job prospects and increasing consumer confidence are making the segment a great space to stay invested in (see: all the Consumer Discretionary ETFs here).

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.4% in August, indicating the improving health of the consumer sector. Additionally, the recent consumer sentiment survey has also been extremely positive with the latest reading surpassing expectations. The monthly Consumer Confidence Index, measured by the Conference Board, climbed to 103 in September from a revised 101.3 in August.

The University of Michigan consumer sentiment index rose to 92.1 in early October from 87.2 in September, indicating that economic recovery is on track despite the twin attacks of a strong dollar and weak global demand that have hurt the industrial sector, especially manufacturing.

Holiday Optimism

With Halloween around the corner and Christmas just eight weeks away, the consumer discretionary sector is expected to gain the most from the holiday shopping season.

The National Retail Federation (NRF) expects sales in November and December (excluding autos, gas and restaurant) to grow at a solid pace of 3.7%. Though this marks a deceleration from the last year’s growth rate of 4.1%, it is well above the 10-year average of 2.5%. A recent survey by Gallup showed that Americans intend to spend an average $812 on gifts this holiday season, up from $781 last year and the highest expected spending since 2007.

Positive comments from some of the leading retailers confirmed this trend. In fact, the world's largest retailer Wal-Mart (WMT - Analyst Report) has kicked in a layaway program two weeks earlier, providing shoppers 90 days’ credit instead of 60 previously while Target (TGT - Analyst Report) has expanded its price-match policy from 5 to 29. Additionally, the second largest courier company FedEx (FDX - Analyst Report) is seeking a 12.4% rise in shipments to a record of 317 million from Black Friday through Christmas Eve.

Solid Industry Outlook

About two-thirds of the industries falling under the consumer discretionary sector have a very attractive Zacks Rank of 2.00–2.64 while 16% has an attractive Rank of 2.65–2.81, underscoring their outperformance in the coming months. That being said, apparel topped the list, followed by consumer electronics and other consumer discretionary items.

Impressive Third Quarter Earnings

Per the Zacks Earnings Trends, consumer discretionary has been showing impressive growth, outpacing the S&P 500 index. This is especially true as total earnings for 23.6% of the sector having reported so far are up 5.7% on 1.3% higher revenues compared with the S&P 500 earnings growth of 2% and revenue decline of 2.1% (read: 5 Sector Favorites for Q3 Earnings & Their Hot ETFs).

Top ETFs to Consider
 
In view of the reasons discussed above, we strongly believe that investors should consider consumer discretionary ETFs. We have highlighted three ETFs having the top Zacks Rank of 1 or ‘Strong Buy’ that provide a broad exposure to the sector:

Vanguard Consumer Discretionary ETF ((VCR - ETF report))

This fund follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index and holds 384 stocks in its basket. This is the low choice in the space, charging investors just 12 bps in annual fees while volume is also solid at nearly 150,000 shares a day. The product has managed over $2 billion in its asset base so far.

The fund is pretty spread across a number of sectors and securities with a slight tilt toward Amazon (AMZN - Analyst Report) at 7% while other firms hold no more than 5.7% share. Internet retail, restaurants, and movies and entertainment are the top three sectors accounting for over 10% of total assets. VCR has gained 8.9% so far this year (read: Amazing Q3 at Amazon: ETFs to Benefit).

First Trust Consumer Discretionary AlphaDEX Fund ((FXD - ETF report))

This follows an AlphaDEX methodology and ranks stocks in the space by various growth and value factors, eliminating the bottom ranked 25% of the stocks. This approach results in a basket of 129 stocks that are well spread out across each security with none holding more than 1.53% of assets. Specialty retail is the top sector with nearly one-fourth of the portfolio, closely followed by media (15.8%).

FXD is one of the popular and liquid ETFs in the consumer discretionary space with AUM of $2.4 billion and average daily volume of 473,000 shares per day. It charges a higher 70 bps in annual fees and has delivered flat returns in the year-to-date timeframe.

PowerShares DWA Consumer Cyclicals Momentum Portfolio ((PEZ - ETF report))

This product tracks the DWA Consumer Cyclicals Technical Leaders Index and provides exposure to 38 consumer stocks having positive relative strength (momentum) characteristics. It is slightly skewed toward the top firm – O'Reilly Automotive (ORLY - Analyst Report) – at 5.4%, while other securities have a spread-out exposure, with each holding less than 4.3% share (read: 2 ETFs Rising to Rank #1 This Earnings Season).

About 29% of the portfolio is dominated by specialty retail while hotel restaurants and leisure, textiles apparel and luxury goods, and airlines round off the next three positions with double-digit exposure each. PEZ is often overlooked by investors as depicted by its lower AUM of $247 million and moderate average daily volume of 53,000 shares. The expense ratio came in at 0.60%. The product has added about 5% so far this year.