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Summary

  • Quality and low volatility strategies may help counter disappointing retail sales, slowing refinance activity and sluggish retail spending.
  • During times of weak consumer demand, the quality factor has historically outperformed the S&P 500 Index.
  • Portfolios with lower volatility may offer investors some defense against soft retail sales growth.

By Nick Kalivas

Retail earnings have tended to disappoint this profit season. With 20 out of 31 retail members of the S&P 500 Index reporting earnings as of May 20, 2014, only seven companies exceeded forecasts, while eight fell short of estimates. As a result of soft profits and expectations for sluggish consumer spending, the S&P 500 Retailing Index is trading at 10.6% below its high of Dec. 27, 2013.

Refinancing revved up retail

While headwinds stemming from the harsh winter - higher heating bills and reduction of work hours, for example - weighed on disposable incomes, reduced refinance activity may also be taking a toll. The graph below illustrates the relationship between the MBA Refinance Index pushed forward one year (the index leads retail sales by about one year) and the year-over-year growth in retail sales, excluding gasoline and food, deflated by the CPI to adjust for inflation. Notice that spikes in refinance activity have tended to lift retail sales growth, while lulls in refinance activity have been consistent with more sanguine consumer spending. Although the recent decline in long-term Treasury interest yields has stopped the fall in refinance activity, the level remains depressed compared with the level over the past 10 years.

Refinance Activity Spurred Retail Sales

(click to enlarge)

Source: Bloomberg L.P., as of May 20, 2014

But refinance isn't the only driver of consumer spending; fuel prices and wage and salary growth are also important drivers. As you can see, the graph argues for soft sales into the spring of 2015.

Weathering the refinance slowdown

Against this backdrop, what can investors do? Here are two ideas you may want to consider discussing with your financial advisor.

1. Quality companies have characteristics - such as strong, consistent earnings growth and high returns on equity - that may be supportive of generating higher long-term returns than those of average stocks. The quality factor has historically been able to outperform the S&P 500 Index during periods of weak consumer demand. For example, the graph below illustrates the relationship between performance of the PowerShares S&P 500 High Quality Fund (NYSEARCA:SPHQ) and year-over-year growth in retail sales, excluding gasoline and food, deflated by the CPI to adjust for inflation. When sales growth was sliding between the middle of 2006 and 2008, the fund outpaced the index. The fund did underperform, however, in the wake of the financial crisis when oversold non-quality stocks rebounded as investors drove share prices to extreme lows by raising cash indiscriminately. But as the graph shows, quality has held up in recent years as sales growth has eased lower.

Quality Has Generally Outperformed During Periods of Weak Consumer Demand

(click to enlarge)

Source: Bloomberg L.P., as of May 20, 2014. Returns based on market prices.

2. A low-volatility portfolio may provide another avenue of defense against slower retail sales growth. For example, the PowerShares S&P 500 Low Volatility Fund (NYSEARCA:SPLV), based on the S&P 500 Low Volatility Index, provides exposure to stocks with the least variability in return over the past 52 weeks. Out of 100 current holdings as of May 27, 2014, the fund has only a few retailers as defined by the Global Industry Classification Standard. Home Depot (NYSE:HD) (0.95%) is the only classification in retailing; Costco (NASDAQ:COST) (1.00%), Wal-Mart (NYSE:WMT) (1.20%) and CVS Caremark (NYSE:CVS) (0.94%) are in food and staples retailing; and McDonald's (NYSE:MCD) (1.23%) is in consumer services. These five names total 5.32% of the fund. In contrast, the S&P 500 Index holds 31 retailing names, 19 consumer durable and apparel companies, 13 consumer service names and eight food and staples retailers. These 71 names account for 9.45% of the index.

In the face of a slowdown in refinance activity and potentially soft retail activity well into 2015, quality and low volatility may be strategies to consider for your portfolio. Talk with your advisor about how they may fit into your long-term investment plan.

Important information

Performance data quoted represents past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data quoted. See invescopowershares.com to find the most recent month-end performance numbers. Market returns are based on the midpoint of the bid/ask spread at 4 p.m. ET and do not represent the returns an investor would receive if shares were traded at other times. The gross expense ratio for SPHQ is 0.43% as outlined in the current prospectus.

Standardized Performance for SPHQ

Source: Bloomberg L.P., as of May 27, 2014

Holdings are subject to change and are not buy/sell recommendations.

The S&P 500 Index is an unmanaged index considered representative of the U.S. stock market. The S&P 500 Retailing Index is a subset of S&P 500 Index stocks in the retail business. The MBA Refinance Index attempts to track the volume of mortgage loan applications that have been submitted to lenders by borrowers looking to refinance their mortgages. The consumer price index (CPI) measures the prices consumers pay for a basket of consumer based goods and services. The growth rate can be used to define the level of inflation in the economy. The Global Industry Classification Standard was developed by and is the exclusive property and a service mark of MSCI, Inc. and Standard & Poor's.

Past performance cannot guarantee comparable future results.

Find out more about PowerShares S&P 500 High Quality Portfolio and PowerShares S&P 500 Low Volatility Portfolio.

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund's return may not match the return of the underlying index.

PowerShares S&P 500® High Quality Portfolio (FUND) is based on the S&P 500® High Quality Rankings Index (Index). The fund will normally invest at least 90% of its total assets in common stocks that comprise the index. The index is designed to provide exposure to the constituents of the S&P 500 Index that are identified as stocks reflecting long-term growth and stability of a company's earnings and dividends. The fund and the index are rebalanced and reconstituted quarterly.

Investments focused in a particular industry are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

Equity risk is the risk that the value of equity securities, including common stocks, may fall due to both changes in general economic and political conditions that impact the market as a whole, as well as factors that directly relate to a specific company or its industry.

PowerShares S&P 500® Low Volatility Portfolio is based on the S&P 500® Low Volatility Index (Index). The Fund will invest at least 90% of its total assets in common stocks that comprise the index. The index is compiled, maintained and calculated by Standard & Poor's and consists of the 100 stocks from the S&P 500® Index with the lowest realized volatility over the past 12 months. Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time. The fund and the index are rebalanced and reconstituted quarterly in February, May, August and November.

The fund is considered non-diversified and may be subject to greater risks than a diversified fund.

Investments focused in a particular industry are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

Equity risk is the risk that the value of equity securities, including common stocks, may fall due to both changes in general economic and political conditions that impact the market as a whole, as well as factors that directly relate to a specific company or its industry.

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The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is a U.S. distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts.

Before investing, investors should carefully read the prospectus.

Invesco unit investment trusts are distributed by the sponsor, Invesco Capital Markets, Inc. and broker dealers including Invesco Distributors, Inc. These Invesco entities are indirect, wholly owned subsidiaries of Invesco Ltd.

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