PEJ Could Benefit From Pent-Up Demand
- Until last year, PEJ had traditionally been a consistent return-generating source.
- Leisure and hospitality companies are looking to go more digital and boost productivity as employment trends will take a long time to normalize.
- The delta variant has recently dampened some of the consumer enthusiasm for travel-related spending.
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A vacation is what you take when you can no longer take what you’ve been taking. - Earl Wilson
Last month, I had put on a tweet on the timeline of The Lead-Lag Report, highlighting how well the consumer discretionary sector had fared over the last 12 years or so. Considering that consumer spending accounts for over two-thirds of US GDP, this is an area that one shouldn’t disregard if you happen to be bullish on the prospects of the US economy. There are different ways to play this high alpha-generating sector; over the last 12-18 months, a lot of goods-based consumer discretionary stocks benefitted from the stimulus support measures of the federal government as consumers chose to divert all their excess savings here. Going forward, I would be inclined to think that the services side of consumer discretionary could pick up the baton. This is a segment within consumer discretionary that was adversely affected by lockdown restrictions and health-related fears. Now, with almost 70% of the population having procured the vaccine and fears gradually abating as herd immunity picks up, I suspect we could see this pocket benefit from a lot of pent-up demand waiting to be unleashed. It is believed that American households had accumulated excess savings to the tune of $2.5 trillion last year on account of the pandemic. As pointed out in The Lead-Lag Report, we’ve already seen some evidence of this rotation from goods to services.
If this is a theme that appeals to you, you may consider looking at Invesco Dynamic Leisure and Entertainment ETF (NYSEARCA:PEJ). Until last year, the ETF had a fairly consistent track record in delivering positive returns in nine out of the past ten years (in CY20, it delivered negative returns of -10%).
PEJ covers a portfolio of over 30 stocks, focusing on companies that are principally engaged in the design, production, or distribution of goods or services in the leisure and entertainment industries. These companies may include hospitality companies such as hotels, restaurants and bars, cruise lines, casinos, and all other recreation and amusement businesses; as well as entertainment programming companies engaged in the production of motion pictures, programming for radio and television, music-related, movie theaters.
Whilst half the portfolio comprises of large-cap names (market cap of >$13bn), PEJ also dabbles with mid-caps (32% weight) and small caps (18% weight). PEJ’s methodology involves evaluating these leisure and hospitality names via 5 broad categories - price momentum, earnings momentum, quality, management action, and value. I would have liked a bit more clarity on how PEJ’s tracking index goes about its selection process, but all they say is that “they go beyond traditional measurements to consider the fundamentals that drive healthy companies and growth” within this space.
Considering this is a niche ETF, the expense ratio isn’t particularly cheap at 0.69%. Besides, if you’re someone who likes a stable portfolio, then PEJ may not be the best choice, given that the fund manager frequently revamps the portfolio. As per the most recent data, the annual portfolio turnover rate worked out to a whopping 163%! Worth noting that the most recent reconstitution exercise will take place sometime in August (this happens on a quarterly basis).
The outlook for the leisure and hospitality segment looks largely resilient, although a few risks have cropped up off late. Firstly, according to PWC, excess personal savings at the start of 2021 stood at roughly $1.5 trillion, and a bulk of this was sitting with the upper-income households who typically tend to have a predilection for discretionary spending in leisure and hospitality activities.
Employment trends within an industry are also a useful way of gauging how things are progressing within that industry and as pointed out in The Lead-Lag Report last week, nearly 40% of the total jobs added in June came from the leisure and hospitality sector alone.
That said, despite this recent surge please note that things are far from normal here and a recent report by The American Hotel and Lodging Association showed that one in five of the nationwide lodging jobs lost during the pandemic would not come back even by Jan 2022; you’re basically talking about nearly half a million jobs. In fact, Fitch Ratings believes employment here won't necessarily return to pre-pandemic levels until 2024. This doesn't necessarily have to be a bad thing for the leisure and hospitality stocks of PEJ as this could be the perfect opportunity to help kickstart productivity trends within the industry. We're already seeing some evidence of this; as pointed out in The Lead-Lag Report, some notable restaurant-based stocks have begun to address their staffing-related challenges by shifting to more digitized and automated offerings. You may not immediately see the benefits of this, given the high upfront investment costs, but over time, we could see ROIs improve as operating leverage kicks in.
The other thing to note is how profound the impact of the delta variant could prove to be for travel sentiment and the like. In June, travel spending of $87.6 billion was only ~15% below June 2019 levels, “a significant improvement from earlier months" but worryingly comfort levels in taking vacation have started plateauing. At the start of July, 65% of consumers said they felt comfortable taking vacations, but the delta variant is looking to put a spanner in the works, and this has resulted in the figure dropping to 61%.
Source: Morning Consult
Investors looking out for under-tapped post-pandemic related themes in the stock market may consider the ETF - PEJ which could also benefit from consumer spending rotation from goods to services. Traditionally, this is an ETF that tends to trade at over 25x weighted average P/E, but as per the latest data from YCharts, you can currently pick this up at 19x P/E.
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