In Retail, High End’s Pain Is Low End’s Gain

by Daniel Putnam | June 27, 2012 12:03 pm

It’s the best of times and the worst of times … in the retail sector, at least.

In the past two months, luxury brands have been hit extremely hard in the market downturn, while the low-end retailers have continued to rally with virtually no interruption. If this comes as a surprise, it shouldn’t — throughout the past five years, the two segments of the retail sector have generated highly disparate performance based largely on the macroeconomic environment.

The table below shows the extent of the divergence between the two sectors during crisis periods and subsequent recoveries. When the market is in crisis mode — the meltdown of 2008 and the Europe-related volatility in each of the past three years — the low end tends to hold up very well on a relative basis. In the subsequent recoveries, it’s the luxury retailers that have led the way.

So forget about individual stock picking — investors’ success in these two areas has been almost entirely a function of the state of investor risk appetites.

Crisis RECOVER Euro Fears 1 RECOVER Euro Fears 2 Recover Euro Fears 3
Wal-Mart WMT 20.4% 5.2% -9.9% 13.3% -1.6% 15.0% 15.9%
Dollar General DG -3.6% 23.0% 11.4% 25.7% 10.0%
Dollar Tree DLTR 8.0% 36.3% 2.8% 60.0% 12.8% 35.3% 11.6%
Family Dollar FDO 31.9% 20.8% -4.4% 41.4% -2.9% 33.7% 7.6%
Ross Stores ROST 40.1% 57.8% -4.5% 52.1% -1.5% 57.1% 10.7%
TJX Companies TJX -10.2% 83.3% -9.2% 26.9% 6.0% 51.2% 4.5%
Average 18.0% 40.7% -4.8% 36.1% 4.0% 36.3% 10.1%
Coach COH -64.5% 152.3% -12.1% 77.2% -18.6% 42.1% -15.1%
Tiffany TIF -59.1% 129.3% -21.4% 110.9% -22.2% 13.6% -21.1%
Ralph Lauren RL -45.6% 113.7% -18.7% 82.7% -2.1% 33.2% -14.4%
Nordstrom JWN -62.9% 152.4% -21.7% 49.0% -2.2% 23.6% -8.2%
Saks SKS -89.3% 421.4% -22.2% 47.2% -21.7% 25.3% -3.6%
Blue Nile NILE -68.5% 79.1% -12.8% -6.6% -19.8% -14.2% -0.7%
PVH Corp. PVH -57.6% 179.0% -26.5% 41.9% -11.0% 52.6% -9.0%
Lululemon Athletica LULU -79.9% 334.4% -1.1% 200.4% 12.9% 52.3% -13.1%
Average -65.9% 195.2% -17.1% 75.3% -10.6% -28.5% -10.7%
SPDR S&P Retail ETF XRT -41.3% 89.1% -16.3% 51.2% -13.2% 34.4% -4.4%

Investors can take several things away from this data:

First, being right on low-end retailers versus high-end ones isn’t just a matter of losing a few basis points here and there. The differences can be enormous. Even tossing out the 2008 crisis and subsequent recovery, the performance gap between the two segments has been almost 19 percentage points.

The second item that jumps out from the data is the tremendous outperformance for the lower-end names when the entire period is taken into account. The low-end basket has managed to post an average gain of 6.1% during the crisis periods, while the high-end group has averaged a loss of 26.1%. In the recovery phases, the high-end names have delivered gains of 99.7%, but the low-end stocks have held their own with an average return of 37.7%.

All of this brings us to the current state of affairs for retail stocks. The low end has outpaced the high end by more than 20 percentage points in the past two months. This rally has been fueled by across-the-board moves to all-time highs in all of the discounters, with the exception of Wal-Mart (NYSE:WMT[1]), which itself is on the verge of surpassing its former peak established in 1999.

Several factors have come together to fuel this massive performance gap.

Foremost among these is the decline in consumer confidence, which has a disproportionate impact on the luxury brands. While the low end is helped by shoppers’ decision to trade down, luxury companies receive no such benefit.

The past two months also has seen growing worries about the European debt crisis and the oncoming fiscal cliff in the United States, both of which are much more likely to hit the radar screens of higher-end shoppers. At the same time, the impact of falling gas prices has a much larger marginal impact on the spending patterns at the lower end.

And, not least, the luxury brands are heavily exposed to the slowing growth in China and Europe, whereas the same cannot be said for the Dollar Generals (NYSE:DG[2]) of the world. Added together, these factors represent the ideal backdrop for the discount retailers.

What’s next for these two groups? It seems dangerous to chase the discounters here given how much they have gained in the past nine months, but it’s also folly to bet against them as long as stories about the fiscal problems in the U.S. and Europe continue to pepper the headlines. Instead, the best trade here is be ready to jump into the luxury names as soon as investors have a reason to push the “risk on” button again.

The moral of the story? If you want to evaluate retail stocks this summer, go ahead and toss your Graham & Dodd book out the window. For now, it’s the daily macro headlines that are going to make or break your trade.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

  1. WMT:
  2. DG:

Source URL:
Short URL: