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How to Play Retail as Consumer Tightens Belt

Retail ETFs are still fairly strong, but some say individual stock names might be best for now, as consumers get stretched ever thinner.

Retail-focused ETFs have declined less than funds in many other sectors of the market, but whether they can continue outperforming is subject to debate.

Year-to-date, the

PowerShares Dynamic Retail Fund

(PMR) - Get Invesco Dynamic Retail ETF Report

, the

Retail HOLDRs Fund

(RTH) - Get VanEck Retail ETF Report

and the

SPDR S&P Retail Fund

(XRT) - Get SPDR S&P Retail ETF Report

are down 4.5%, 6.0% and 11.3%, respectively. These funds have held up well compared with the

S&P 500

, which is down 13.7% so far this year.

Now, some market observers are saying the retail sector may be the next to crack.

Ken Perkins, president of

Retail Metrics

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, sees macroeconomic conditions as being a major challenge for the retail sector.

"Certainly the next year or so is going to be dicey, to say the least," he says. "Some of the weaker players will be shaken out. Once the price of gas went above $4 a gallon, it really began to impact consumer psychology."

Perkins cites a tight job market as being a potential drag on the retail sector.

"We see job losses continuing through the rest of the year," he says. "It could be very tough sledding over the next year or so."

Changing Demographics

Potential changes in spending habits could also prove to be an obstacle for retailers in the not too distant future.

"The industry is going to be really challenged for the next few years," says Keith Springer, president of

Capital Financial Advisory Services

. "We are turning from a nation of spenders to a nation of savers."

Springer believes that changing demographics could lead to a decline in consumer spending.

"The last wave of Baby Boomers is about 48 years old now," he says. "As people approach retirement, they tend to cut back on spending. By that point, a lot of their necessary spending is declining."

Despite a negative sentiment toward the retail sector, Springer does recommend that individual investors consider the use of an ETF, such as the Retail HOLDRs, if they are of the belief that the sector is due for a pop.

The Retail HOLDRs Fund's top holdings include

Wal-Mart Stores

(WMT) - Get Walmart Inc. Report


Home Depot

(HD) - Get Home Depot, Inc. Report



(TGT) - Get Target Corporation Report





"RTH would be the best way to invest in retail," Springer says. "The risk in not being properly diversified is too high. You can be right on a sector, but wrong on a stock."

Value Play or Value Trap?

Steven Rogé, co-portfolio manager for the

Rogé Partners Fund


, believes that some of the hurdles that face retailers may already be taken into account.

"The stocks have come down a lot over the past year, so I think that the headwinds that they face have been priced in to some extent," he says. "With reasonable valuations, it certainly wouldn't hurt to dip your toe back into the space."

For investors looking to add retail positions but who are not sold on these ETFs, Rogé likes the clothing retailer

American Eagle Outfitters

(AEO) - Get American Eagle Outfitters, Inc. Report

. Last month, the company maintained its second-quarter guidance.

"American Eagle is our favorite name in the retail space right now," he said. "They are trading at a reasonable valuation, have an astute management team and have a very high margin business for a retailer."

Another apparel retailer that has caught Rogé's eye is


(GPS) - Get Gap, Inc. Report

, which recently reported a 7% decrease in its comparable store sales for the month of June.

"Purely on a valuation basis, Gap looks pretty interesting," he said.

Perkins also points to a couple of clothing retailers as being among the best positioned companies in the sector. The names that he finds to be most appealing in retail are




Urban Outfitters

(URBN) - Get Urban Outfitters, Inc. Report


"Right now, it is really a stock-picker's market," he says of his hesitancy to embrace the ETFs.