Retail ETFs: Buy Low Opportunity or Avoid?

There’s a lot going on in the retail sector right now and a lot of it isn’t good. While the S&P 500 sits only about 1% off its highs, the SPDR S&P Retail ETF (XRT) is more than 12% off its 52 week highs. Retailers are continuing to deliver disappointing holiday sales numbers. Brick and mortar companies like Kohl’s (KSS) and Macy’s (M) have been some of the S&P 500’s worst performers in 2017. Under Armour (UAA) plunged as it reported weak revenue growth and lowered guidance. UPS (UPS) also missed in the 4th quarter. Plus, there’s the gray cloud of a potential border tax that could negatively impact both businesses and consumers.

There are two ways to approach the retail sector from this point.

First is as a value opportunity. While the migration from in-store to online sales will continue to grow, the Trump border tax, which is currently spooking retailers since it will increase the cost of overseas manufacturing, is far from a sure thing to get passed through Congress. In fact, many peg it as a less than likely possibility. The strong dollar is also a concern since it makes goods for foreigners more expensive but Trump has already given indications that he’s willing to abandon the long-standing strong currency policy. If there’s no border tax and the dollar weakens (it’s dropped pretty consistently through January), retail has the look of a potential buy low candidate.

The other, however, is to view the current environment as a broad shift in the retail landscape. The move to online retail is not going to slow down and the weakness we’ve seen in some of the country’s biggest retailers may only continue. If the border tax does become a reality, we’re looking at billions of dollars in added expenses for the largest retailers such as Walmart (WMT) and Target (TGT). Unfortunately, those costs usually get passed on to the consumer. Higher costs equal lower consumer spending hurting retail even further and the cycle continues.

Let’s not forget also that many retailers are starting to see their bond issues slip into the junk category. Some of these companies aren’t going to survive as the combination of slowing revenue growth, increased costs and higher debt loads prove to be too crippling. For the ones that do survive, they might find themselves in a pinch since expensive borrowing costs impact the bottom line if they’re not shut out of the credit markets altogether.

Amazon’s (AMZN) earnings later this week should be a good indicator of the health of the retail sector overall. It has been stated famously that Amazon has the market cap of the next half dozen largest retailers combined as they’ve benefited from the big move to online shopping. Trouble at Amazon could mean the retail sector is in real jeopardy. Under Armour stock got hammered when it reported a significant slowdown in growth. What would it look like if Amazon did the same?

There’s a case to be made for buying the dip in selective companies but the retail sector as a whole looks too troubled right now for my liking. I tend to believe that it’s more likely than not that we won’t see a border tax implemented but the fundamental shift in the landscape coupled with the weak sales environment we’ve seen almost across the board tells me that this is a sector that’s best avoided.

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