Daily Gains Letter

Time to Invest in What Consumers Need?

By for Daily Gains Letter |

Time to Invest in What Consumers NeedConsumer confidence seems to be deteriorating in the U.S. economy, and if it diminishes further, any economic growth will become questionable. When consumers are confident, they go out and spend, resulting in an increase in the consumer spending, which makes up 70% of the gross domestic product (GDP) of the U.S. economy.

Recently, clothing store chain Abercrombie & Fitch Co. (NYSE/ANF) reported that the company’s corporate earnings fell 33% in the second quarter of this year from the same period a year ago. The company’s same store sales declined 11% in the U.S. economy; this resulted in Abercrombie & Fitch lowering its outlook for the third quarter’s corporate earnings. (Source: “Abercrombie & Fitch Profit Slides, Cuts Outlook,” The Wall Street Journal, August 22, 2013.)

Sadly, when it comes to clothing stores, Abercrombie & Fitch wasn’t the only one that became the victim of diminishing consumer confidence; Aeropostale, Inc. (NYSE/ARO) faced scrutiny as well. The company registered a loss of $37.0 million in the second quarter, with the same store sales for the company declining 15%. Aeropostale was also hesitant about its outlook: “Our negative outlook for the third quarter reflects the challenges of a highly promotional and competitive teen retail environment which we expect will continue,” said Thomas P. Johnson, the company’s CEO. (Source: Ibid.)

While the above companies were mainly clothing stores, other retail giants like Wal-Mart Stores, Inc. (NYSE/WMT) and Macy’s, Inc. (NYSE/M) complained about consumer confidence as well, citing an increasingly tough business environment.

Here’s what you need to know: Companies, especially retailers of any sort, see trends in consumer confidence through their sales. If consumer confidence declines, their sales follow in the same direction.

According to The Conference Board, the index tracking consumer confidence in the U.S. economy declined a little more than 2.1% in July. It stood at 80.3 compared to 82.1 in June. (Source: “The Conference Board Consumer Confidence Index® Falls Slightly,” The Conference Board web site, July 30, 2013.) After looking at what companies on key stock indices had to say, it wouldn’t be surprising to see it decline further.

For investors, this means they need to be very careful when it comes to companies involved in the consumer discretionary sector.

The reasoning behind this is very simple: as stated earlier, when consumer confidence declines, consumers tend to spend less money on things they want, compared to what they need. Therefore, those companies that sell products consumers don’t really need end up facing a rough patch. Would you go buy a new laptop if you think you might lose your job in the next few months and have no savings? I hardly think so.

For their portfolio, investors may want to look for opportunities in a space where consumer confidence doesn’t really affect a company’s sales. Consider a company in the consumer staples sector—things people can’t really avoid buying—or even exchange-traded funds like Consumer Staples Select Sector SPDR (NYSEArca/XLP).

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