Tuesday, May 19, 2009

It's All About the Consumer

Written by: Andrew Giovinazzi

Consumer spending comprises approximately 70% of GDP
The unemployment rate remains high and continues to grow
Personal savings as a % of disposable income is high, but for how long?

I started with an idea on consumer spending and let AlphaVision™ show me how the market reacted to the sectors shown below after the recently updated Chain Store Sales[1] report. Sometimes simple investment concepts require simple analysis. The investment community has been focused on financial institutions (rightfully so, I might add) and the end of civilization as we know it; however, the truth is, it’s all about the consumer. Overall, financials have made sharp gains in 2009, most of them after investors digested news on banks’ stress tests and Bernanke’s optimistic expectation that the economy would recover late this year. Since short-term financial plays have been realized, what’s next? To answer this, let’s focus on consumer spending.

To see potential consumer targets (and investment targets) I looked at two sectors: Retail - Discount Stores and Retail - Drugs, the two largest outliers responsible for improvement in the Chain Store Sales report. Using AlphaVision™, I scaled these two sectors for YTD price % changes.

The metrics reveal that Wal-Mart’s (WMT) price is down nearly 7% YTD while Family Dollar (FDO) has gained over 25%. Relative to the S&P 500, FDO has gained over 38%. In the retail drugs sector, Rite-Aid (RAD) and Walgreens (WAG) seem to be making the most noise. RAD gained about 29% and WAG is up 11% YTD. Using AlphaVision’s Metric Scout [see screen shot below], I pulled a side-by-side view of YTD, YTD relative to S&P500, and month-to-date price % changes. Looking at month-to-date percent changes, it appears the retail drugs sector has made impressive gains recently and therefore, does not look as attractive[to buy] as the retail discount stores.

If the economic recovery isn’t realized as soon as Bernanke thought, consumers could continue to substitute large scale discount retailers with dollar stores. Perhaps going long FDO (and/or DLTR, Dollar Tree) and shorting WMT is a good strategy. If the worst is over and the bottom is struck, consumers will “gradually” make their way back to WMT – remember to keep an eye on personal savings and unemployment. This scenario would suggest going long WMT and short FDO. In either case, consumers will never completely stop shopping at retailers such as WMT. While I am not as optimistic about the recovery as the Federal Reserve, I believe FDO is poised for a pullback given its YTD upswing relative to other stocks in its sector. Shorting FDO and going long DLTR could be a good relative value play, or for the long-term value investor, simply going long WMT could make sense.

[1] Source: Moody’s Economy.com and the International Council of Shopping Centers