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| TSLA | $585.76 | +2.05% |
The Trader: Tesla Is About to Upend This Sector. What Investors Should Do Now. -- Barron's
By Ben Levisohn
Tesla isn't just getting added to the S&P 500 -- it's getting added to the S&P 500 consumer-discretionary index as well. And that could make the sector a whole lot riskier than it already is.
Investors should consider playing it through alternative indexes or even individual stocks.
The consumer-discretionary sector has gained 29% in 2020, making it the second-best performer this year, behind only tech.
Amazon.com (ticker: AMZN), up 72% through Nov. 24, has done most of the heavy lifting, but Tesla (TSLA) has performed even better. It's up a ridiculous 564% in 2020, and if it had been added to the S&P 500 at the start of the year, the consumer-discretionary sector would have gained a whopping 44%, according to Ned Davis Research.
Investors can't fret about what could have been, but they should be concerned about what could be. Tesla, which is set to be added to the S&P 500 on Dec. 21, will be the second-largest component in the consumer-discretionary sector, with a weighting of 12% based on Nov. 24 prices, Ned Davis Research estimates, putting it ahead of Home Depot (HD), which currently has an 8.6% weighting. Amazon's weighting, at a hefty 42.3%, according to Ned Davis Research, will fall to 37.3%. The sector, already 11.9% of the S&P 500, will constitute 13.3% of the index.
Not only will consumer discretionary become bigger, it will become riskier too. Its market beta, a measure of its volatility relative to the S&P 500, will rise from 1.2 to 1.3, and its realized volatility will increase to 5.6% from 4.8% on a 26-week basis. That means the sector, already more volatile than the S&P 500, will get even wilder once Tesla makes its entrance.
Index investors will be buying Tesla stock after a massive run-up in a sector that itself has already seen a surge. Ned Davis Research notes that the consumer-discretionary sector with Tesla would have gained 50% over the past 252 days, 34 percentage points more than the S&P 500. That's 3.6 standard deviations above the norm, up from 2.9 standard deviations without Tesla. There's nothing that says Tesla -- and consumer discretionary -- can't keep heading high, but we'd like to believe that gravity will take hold at some point.
What's an investor to do? One option is to buy the Invesco S&P 500 Equal Weight Consumer Discretionary exchange-traded fund (RCD), which counts luxury-goods purveyor Tapestry (TPR) as its largest current position, with a 2.6% weighting. The ETF also rebalances at the end of each quarter, so no company stays too big for too long.
It's not a perfect solution. With an expense ratio of 0.4%, the Equal Weight ETF isn't as cheap as the Consumer Discretionary Select Sector SPDR ETF (XLY), which charges just 0.13%. It also has just $305 million in assets under management, so isn't the most liquid ETF in the world. Still, it may be the best choice for playing the sector.
Of course, investors can also place their bets on the sector through individual stocks. One that looks promising: Polaris (PII). The company makes off-road vehicles, snowmobiles, and boats, among other products, and for a moment there it looked like it would be one of the big winners of the Covid-19 crisis. The stock gained 159% from March 23 through Aug. 13, when it peaked at $106.98. Since then, it has dropped 11% to $95.54.
Investors aren't sure how long the boost from the virus will last for Polaris. The stock was also dinged when its CEO, Scott Wine, announced after the close on Nov. 17 that he was leaving Polaris for CNH Industrial (CNHI), causing Polaris to fall 6.3% the next day.
Despite the big drop, however, Polaris managed to stay within its range, reinforcing its support near $90 a share. And the stock looks like it could be ready to make a move back to the top of its range. On Nov. 25, Citigroup strategist Scott Chronert added the stock to the firm's small- and mid-cap focus list, as well as its Value Creators list.
Chronert cited the fact that Polaris is a traditional economically sensitive consumer-discretionary stock, but also that its products benefit from the fact that the pandemic has made people want to spend more time outside. He also called Polaris' valuation "attractive" -- it trades for 12.6 times 12-month forward earnings, according to FactSet -- and cited its strong balance sheet, as well as characteristics that make it attractive to investors looking for bargains or fast growth.
The departure of CEO Wine is certainly a loss. Polaris has returned 476%, including reinvested dividends, during his tenure, which started in 2008, and has easily outperformed the S&P 500 over that period. Still, Baird analyst Craig Kennison notes that Polaris should have little trouble finding a strong replacement.
Read more Trader: Why the Stock Market Keeps Rising -- and Why Its Next Test Comes Next Week
"For 12 years, Mr. Wine led Polaris with the pedal to the metal, driving the company to the pole position in powersports," he writes. "He leaves behind a talented leadership team and an attractive CEO gig that is likely to attract world-class executive talent from inside and outside the company."
Kennison rates Polaris stock Outperform with a $122 price target, up 28% from Friday's close.
Write to Ben Levisohn at Ben.Levisohn@barrons.com
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(END) Dow Jones Newswires
November 27, 2020 21:31 ET (02:31 GMT)
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