PSCD: Overlooked Niche ETF That Investors Should Know For The Next Bull Run

By Kemerey Black

It is difficult to find long-term winners in the stock market in 2023. But that doesn't mean we cannot look ahead to when the current bear market cycle ends. And when we do, we see opportunities like Invesco S&P SmallCap Consumer Discretionary ETF (NASDAQ:PSCD). It was a consistently strong performer versus not only its small cap peers, but also versus the S&P 500 during the years leading up to the current equity bear market.

The chart below shows just how consistently PSCD performed versus not only 2 popular small cap benchmark ETFs, iShares Russell 2000 ETF (IWM) and iShares Core S&P Small-Cap ETF (IJR), but also versus the S&P 500. Importantly, this chart shows 3-year "rolling" returns which means that each date shown is the end of a 3-year "marking period" for the analysis. The chart shows that PSCD is on a streak of 26 consecutive periods of outperformance versus the 2 small cap peers, and has outperformed the S&P 500 ETF in 19 out of those 26 periods. When you consider that record, it is hard to understand why this ETF has only gathered about $65mm in assets, despite being around since the year 2000!

Strategy

PSCD invests in companies that provide nonessential consumer goods and services. Since these are more cyclical sectors, they tend to benefit during periods of economic expansion but may face challenges during an economic downturn. With the risk of a recession on the rise and the possibility of a soft landing seeming less likely, the outlook for nonessential spending is uncertain.

Furthermore, companies included in PSCD tend to be more sensitive to inflation. As costs increase, consumers are less likely to book their dream vacation or go on a shopping spree.

Holding Analysis

PSCD is heavily diversified with over 80 holdings and only 27% in the top 10. Almost 90% of the ETF is allocated to consumer cyclical companies and the remaining 10% is sprinkled across the consumer defensive, technology, industrial, and communication services sectors.

PSCD is diversified across industries within the consumer discretionary sector with the greatest exposure to Specialty Retail (approximately 35%), Household Durables (over 20%), Hotels, Restaurants & Leisure (15%), Auto Components (roughly 15%), and Luxury Goods (almost 8%). These industries have elastic demand, meaning the quantity demanded for goods and services is highly price sensitive.

Strengths

Historically, small cap stocks have tended to outperform their large cap counterparts. In fact, investing in small caps during recessions has historically led to outperformance. However, the small caps focus may not be sufficient to overcome the challenges faced by consumer discretionary companies.

Weaknesses

Investing in PSCD may pose challenges in volatile markets due to the limited liquidity of small cap companies compared to large caps. Furthermore, smaller companies typically have weaker pricing power and may experience margin pressures from ongoing inflation. These factors can hurt returns. Additionally, the consumer discretionary sector was hit hard by supply chain disruptions during the COVID-19 pandemic, and these effects continue to linger. Shaky supply chain conditions have been further compounded by the zero-COVID policy maintained in China and the ongoing conflict between Russia and Ukraine.

Opportunities

In the event of a sudden economic recovery surpassing expectations, PSCD could provide favorable performance. Consumer discretionary companies are tied to the economy, and if the economy does better than expected they might as well. Additionally, consumer discretionary companies could protect their margins through cost-cutting measures and technological improvements that increase operational efficiency.

Threats

PSCD operates in a sector that is currently facing considerable challenges, such as significant demand risk and rising input costs. Additionally, the top performers within the PSCD index may eventually "grow out" of the small cap universe and move on to mid cap or large cap categories. This trend can limit the potential for sustained growth within the ETF.

Conclusions

ETF Quality Opinion

Small cap stocks are generally more sensitive to market shocks and consumer discretionary companies tend to be highly correlated with the overall state of the economy. Given these factors, I believe that caution is warranted when considering an investment in PSCD, particularly during times of economic uncertainty. However, I do not believe that PSCD is a bad ETF in and of itself. Rather, it is simply facing unfavorable market conditions.

ETF Investment Opinion

I have assigned a Sell rating to PSCD given the current economic uncertainty, however, I recognize that it may hold potential value in the future. As such, I have added PSCD to our watchlist of ETFs to monitor for the first signs of the next business cycle.