Consumer cyclicals challenge investor bets

As market uncertainty continues apace, investors hoping to make money by allocating assets to the retail sector could face a disappointing time.

Fiona Laver, investment director, UK equities at Scottish Widows Investment Partnership (Swip), points out that recent data from the British Retail Consortium shows that UK retail sales have fallen by around 1.5% on a like-for-like basis for two months running. This, she says, can be interpreted as showing that consumers want to conserve cash amid ongoing concerns about the state of the global economy.

"Rising gas and electricity bills, combined with a significant increase in the price of running a car as oil prices continue to hit all time highs, are also leading to a reluctance to spend."

“The credit crisis continues to have an impact to the extent that, despite several cuts in UK interest rates over recent months, the cost of mortgages has remained stubbornly high. Banks, faced with an increase in their own funding costs, have been unwilling to pass on these rate cuts to mortgage holders,” Laver adds.

Dennis Wyles, UK fund manager at Resolution Asset Management, agrees that the sector faces risks from a slowdown in the wider economy as well as the housing market, though he points out that retail sales bounced back during May.

“The share prices of retail stocks have bounced off their lows, after a sustained period of poor performance, where even a negative 9% like-for-like sales performance from Next was greeted with relief,” says Wyles.

“High ticket discretionary items such as furniture have fared worst, but clothing has also been weak due to a lack of fashion trends, wardrobes being ‘full’ and poor weather up until recently."

“The main product category which has bucked the trend is entertainment, driven mainly by games, which is one area to experience positive sales growth. Hence HMV and Game Group have been two of the best performers in contrast to M&S and Next.”

Laver adds that WH Smith has also performed relatively well, despite total group sales falling 2% on a like for like basis over the past six months.

“That performance reflects the strength of its travel related outlets at airports and train stations, where sales actually rose over the period,” she says.

The outlook for the retail sector remains uncertain, with a lowering of retailers’ profit expectations likely, and Wyles says the macroeconomic environment will have to improve before consumer regain their confidence to spend.

“Inflation appears sticky and restricting the room for interest cuts from the MPC, so a lowering of inflationary pressures would also help,” he adds.

For Laver, there would have to be a serious improvement in the housing market before the retail sector improves.

“A turn around in the UK housing market would be a helpful starting point for a rebound in consumer confidence,” she says. “Trading updates from a number of the housebuilders together with the latest data on house prices from the Nationwide Building Society suggest that any such turnaround may be some way off.”

2 June 2008