November 17, 2014 - Safeguard Your Portfolio Against Sudden Shifts in Retail Trends
The retail industry in general can be tricky for investors to navigate, but the fashion sector may perhaps be the trickiest of all retail sectors. Fashion trends are constantly changing, and retailers that lose touch with current trends, or are unable to predict where they are headed in the future, can quickly find themselves in trouble.
Typically, fashion shifts are subtle, and retailers can find that a few changes here and there to their product lines that can satisfy consumers. However, sometimes the shift is more dramatic, and a leading retailer can quickly fall out of grace with its target demographic.
Two such shifts have occurred in recent years, and have impacted a wide range of retailers. One shift occurred among teen shoppers, and another occurred in women's apparel.
Teen shoppers are very important to retailers, but unfortunately they tend to go through the most dramatic fashion shifts. Teens who once wanted to display a wealthy look opted to wear brands such as Abercrombie & Fitch (ANF), Gap (GPS) or Aeropostale (ARO). Currently, teens are more interested in playing down their wealth, and instead of wearing traditionally "preppy" brands, they are opting to go with a more dressed down, casual look. In the wake of the shift, both Abercrombie & Fitch and Aeropostale have suffered; with both stocks currently trading at their 52-week lows.
The Gap also ran into problems, but unlike the other two companies, it was able to get its finger back on the pulse of the demographic, and regained some of its "cool factor". As a result the stock began to rebound at the start of 2012, and while the stock has been rather stagnant over the last year, it remains the strongest among its niche.
The other shift has happened in women's apparel, and is similar to what has occurred with teens, in that women have moved away from dress pants and more formal attire, in lieu of more comfortable wear that functions in both work and casual situations.
The new trend is referred to as "athleisure", and it has shaken up the entire retail sector. Women are just as likely to wear yoga pants and sweatshirts to shopping malls and restaurants as they are to wear dresses or slacks. Retailers such as J.C. Penney (JCP) have struggled, while Nike (NKE) and Foot Locker (FL) have been thriving.
What makes the retail sector so challenging to navigate is that trends can shift back at any time. That is the nature of the sector, and just because a certain retailer is struggling today, there is no guarantee that will be the case tomorrow. Unfortunately, most investors are more in tune with stock prices than they with fashion trends, so by the time we learn about a change in trend it is because retail stocks have already reacted, and it is too late to adjust our holdings on time.
Luckily for most retailers, consumer confidence is running at pre-recession levels, so the sector has been good. The stock market is trading at record levels, and gas prices are down. As a result consumers have more discretionary cash to spend. As a result, Wal-Mart (WMT), Nordstrom (JWN) and Macy's (M) are all trading just shy of their highs. Analysts expect holiday sales to rise 4.1% above last year's level, which should help keep momentum in the sector headed into the new year.
Taking all of this into consideration, I reach two conclusions. The first is that it is a good time to get into some retail stocks. If holiday forecasts live up to expectations, retailers should end the year on a high note. The second conclusion is that when taking into account how quickly trends can shift; I would be wary of placing too heavy a bet on any one particular niche in the sector.
A good way to handle the situation would be with a bullish bet on Vanguard Consumer Discretionary ETF (VCR). The exchange-traded fund holds a wide range of discretionary retailers, including but not exclusively, those in the apparel sector. While it holds fashion retailers such as Macy's, Ross Stores (ROST) and Kohl's (KSS), its holdings also include companies such as Amazon (AMZN), Home Depot (HD) and Starbuck's (SBUX).
Due to the wide variety of companies included in the fund, it provides protection against a shift in consumer taste from one retailer to another, while at the same time allows investors to benefit from rising consumer confidence and a strong forecast for holiday spending.
Chart courtesy of stockcharts.com
A nice hedged trade on VCR would be the December 102/107 bull put credit spread. To set up this position, you would sell the December 107 put while buying the same number of December 102 puts for a credit of 30 cents. This trade has a target return of 6.4%, which is 64.7% on an annualized basis (for comparison purposes only). VCR is currently trading at $113.28, so the fund can fall 5.3% and the trade would still realize its full profit.