Are These Retailers Worth the Investment?

By Moe Zulfiqar

Consumer confidence in the U.S. economy is bleak, and if it doesn’t pick up, the economic growth in the U.S. economy will be in jeopardy, and those who are highly affected by it—companies in the consumer discretionary sector—will face troubles.

What many forget is that consumer confidence and consumer spending have a direct relationship; if consumer confidence declines, we generally see consumer spending decline as well. As consumers become worried about their jobs, financial conditions, and/or general economic conditions, they tend to pull back on their spending. Would you go buy a luxury car or big household items if you knew that your job was in jeopardy, or you had no or very little savings?

The Conference Board Consumer Confidence Index, an index that tracks the sentiment of consumers in the U.S. economy, continued its slide in November after sharply declining in October. In November, it sat at 70.4, 2.8% lower from the previous month, when it was 72.4. (Source: “Consumer Confidence Declines Again in November,” The Conference Board web site, November 26, 2013.)

This isn’t all for consumer confidence. One of the clearest examples of bleak consumer confidence was just last week, at the Black Friday sales. We saw consumers become very cost-savvy, which resulted in retailers opening stores early and providing very deep discounts. Early indicators from the National Retail Federation state that consumers spent an average of $407.02 from Thursday through Sunday, down about four percent from what they spent last year. (Source: National Retail Federation press release, December 1, 2013.)

What does it mean for investors?

Investors have to keep a few important factors in mind when looking at consumer confidence in the U.S. economy.

At the very core, if consumer confidence continues to fall further, consumer spending will start to follow the same direction. This can cause the growth rate of the gross domestic product (GDP) to slow, and if consumers aren’t buying, factories will produce less. As a result, businesses will have to make changes to their operations: reducing their labor force, cutting costs, etc.

In addition, investors have to bear in mind that when consumer confidence is declining—and from Black Friday sales, we see they are—their profit margins begin to go down.

My take is that I wouldn’t be surprised to see retailers, especially those in the consumer discretionary sector, face headwinds going forward; this will eventually reflect in their stock prices. Those who already own companies involved in the consumer discretionary sector may want to consider taking some profits off the table. Remember: when investors take profits off the table, their worst-case scenario is still profit.

Those investors who want to profit from this opportunity may do so by shorting exchange-traded funds (ETFs) like the First Trust Consumer Discretionary AlphaDEX FXD. This ETF invests in companies involved in the consumer discretionary sector. Remember that shorting can result in unlimited losses; if investors choose to go ahead with this strategy, they have to be very careful and use proper risk management techniques, in case the trade works against them.

This article Are These Retailers Worth the Investment? was originally published at Daily Gains Letter