Five Reasons to Bet on Retail

Saddam Hussein had invaded Kuwait in the summer of 1990, sending oil surging from about $16 a barrel that spring to about $40 by September. This was an incredible shock at the time, and economic activity practically ground to a halt.

Despite this frightening scenario, retail stocks rallied strongly in late 1990, before the liberation of Kuwait.

2. Retailers have cut back their growth plans, and inventories are lean.

This is extremely important, because few would argue that we aren't "overboxed" here in the United States. New retail expansion projects have been put on the shelf due to lack of financing and/or the sharp drop in retail sales.

Although curtailing expansion might affect the intermediate growth prospects of many retailers, it's a necessity given the prospects of poor economic growth in the coming quarters. Preserving capital and wringing out productivity from existing assets is the correct thing to do to increase shareholder wealth.

Also, inventories are extremely lean right now, because the consumer retrenchment has been ongoing for the last couple of years. Retailers have made adjustments.

3. Gasoline prices have fallen precipitously.

While the increase in unemployment will seriously hurt retail spending, the decrease in gasoline prices represents an increase in disposable income of about $1,000 a year for the average driver. That money is being used to pay off bills and increase savings, to be sure, but a good portion of it will also find its way into retailers' cash registers this season, especially with the increase in perceived bargains and aggressive pricing.

4. The weather has been colder than normal.

Winter has already come to many parts of the country, with the East Coast experiencing below-normal temperatures so far in November. According to the National Weather Service, this is expected to continue for at least another six to 10 days.

Cold weather is decidedly good for retailers because outerwear is a necessity, not a luxury, for consumers. Sure, you can wear last year's winter coat, but will your children still fit into theirs?

---

At the time of publication, Bagley was long WMT, KSS, TGT, CVS, HD, BBBY, AAPL and NKE.

Jeffrey Bagley, CFA, is vice president and senior portfolio manager at Davidson Trust Company in Devon, Pa. Prior to joining Davidson Trust, Bagley was a portfolio manager at McCabe Capital Managers and a sell-side analyst at Schroder & Co. and NatWest Markets. He was also a senior analyst and editor at the Value Line Investment Survey and an investment analyst at The Vanguard Group.