Profiting From Trading Stocks Of The S&P 500 Consumer Discretionary Sector: (iM-Top5(XLY)Select)

• This 5-stock trading strategy with the Consumer Discretionary Sector stocks of the S&P 500 produces much higher returns than the Consumer Discretionary Select Sector SPDR Fund (XLY).
• The universe from which stocks are selected emulates as close as possible the point-in-time holdings of XLY.
• The model ranks the stocks of this custom universe and selects periodically the highest ranked stocks which also satisfy stipulated yield requirements.
• From 1/2/2009 to 10/23/2020 this strategy would have produced an annualized return (CAGR) of 22.7%, more than the 19.3% CAGR of XLY over this period.

Previous articles described profitable trading strategies with the stocks of the Technology Select Sector SPDR Fund (XLK) (article-1), the Consumer Staples Select Sector SPDR Fund (XLP) (article-2), the Healthcare Select Sector SPDR Fund (XLV) (article-3), the Industrial Select Sector SPDR Fund (XLI) (article-4), the Utility Select Sector SPDR Fund (XLU) (article-5), and the Materials Select Sector SPDR Fund (XLB) (article-6) .  Similarly, the consumer discretionary stocks of the S&P 500 can be profitably traded to provide better returns than the Consumer Discretionary Select Sector SPDR Fund (XLY).

Emulating the Consumer Discretionary Select Sector SPDR Fund (XLY)

The analysis was performed on the on-line portfolio simulation platform Portfolio 123.

Since historic holdings of XLY are not published, a custom universe “S&P 500 (DISCRETIONARY)” was constructed from the S&P 500 stocks. A close match to the holding of XLY can be obtained with the FactSet Reverse Business Industry Classifications System and a Portfolio 123 rule having the following syntax:

RBICS(CYCLICALS) or (RBICS(GENMERCH) & FRank(“MktCap”)>50 or RBICS(HOSPITALITY,) & FRank(“MktCap”)>15 or RBICS(COMMEQUIP) & FRank(“MktCap”)>95 or RBICS(PERSONALCARERETAIL) & FRank(“MktCap”)>70) and !Ticker(“AAPL”)

The current holdings of XLY (61 stocks) include 50 stocks from S&P 500 (DISCRETIONARY) custom universe which currently consists of 56 stocks.

Backtesting of S&P 500 (DISCRETIONARY) universe

A backtest from 1/2/2003 to 10/23/2020 with all the cap-weighted stocks in the custom universe shows a 96% correlation with the performance of benchmark XLY and almost identical total returns of about 700% over this period.

In the Figure-1 below, the red graph depicts the performance of the custom universe and the blue graph (partly hidden) the performance of XLY.

One can therefore expect that the custom universe S&P 500 (DISCRETIONARY) will reasonably accurately reflect the holdings of XLY, and stocks selected by the model should not differ much from what would have been selected from a universe of XLY’s actual historic holdings.

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Trading 5 stocks from the custom universe S&P 500 (DISCRETIONARY)

The iM-Top5(XLY)Select trading strategy invests periodically in only five equal weighted stocks from the custom universe S&P 500 (DISCRETIONARY) ranked with the “iM: Quality” ranking system described in this article.

The buy rules require stocks to have a dividend yield greater than 1.0%. Additionally, stocks must have a Non-Manufacturing Altman Z-Score greater than 0.75, a Beneish M-Score less than -1.70 to eliminate companies that are associated with increased probability of manipulations, and a Piotroski F-Score greater than 3. Also, the Price to Earnings Ratio (excluding extraordinary items, for trailing 12 months) must be less than 1.25 times that of the average for the stocks of the S&P 500 index.

A minimum holding period of 4 weeks is specified.  A position is sold based on its rank, or if the percentage from highest close since a position was started becomes less than -15%.

Figure-2 shows the simulated performance of this strategy from 1/2/2000 to 10/23/2020 and also that of the benchmark XLY. The model shows an annualized return of 17.4% (XLY produced 9.3%) and a maximum drawdown of -48% (-59% for XLY). Annual turnover is very low, about 130%. Trading costs of 0.12% of each trade amount were assumed in the simulation.

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Consumer discretionary stocks have performed reasonably well since 2009, with XLY showing a 19.3% annualized return for the period 1/2/2009 to 10/23/2020.  The simulated performance of the trading strategy for the same period is shown in Figure-3. The model outperformed XLY; the backtest shows an annualized return of 22.6% and similar maximum drawdowns.  Annual turnover is very low, about 90%.

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Investment Risk

In the table below are the risk statistics from 2000 to 2020 for the model and XLY relative to the benchmark S&P 500 (SPY). It is evident from the risk measures that the trading strategy carries less risk than investing in XLY or SPY over the longer term.

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Performance comparison with 4% withdrawal rate

The table below compares the annual withdrawal amounts and portfolio values for the trading strategy, XLY and SPY assuming an initial investment of $100,000 at the beginning of 2009 and annual withdrawals of 4.0% of portfolio value.

Total withdrawals and end portfolio value for the trading strategy are 15% and 36% higher, respectively, than what would have been provided by 4% withdrawal rate from a buy-and-hold investment in XLY. Also for the model the average dividend yield over the preceding three calendar years is significantly higher than that of XLY.

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Conclusion

The analysis shows that the iM-Top5(XLY)Select investment strategy would have produced good returns, preferable to a buy-and-hold investment in stock index funds XLY or SPY. Reasonably high withdrawal rates should be possible without depleting the investment.

Moderate trading is required. The model shows a an average annual turnover of about 130% with a position held on average for 40 weeks and not shorter than 4 weeks. The current holdings are listed in the appendix.

Also, at iMarketSignals one can follow this strategy where the performance will be updated weekly.

Appendix

Current Holdings (as of 11/5/2020)

Disclaimer:

All results shown are hypothetical and the result of backtesting over the period 2000 to 2020. No claim is made about future performance.