NEW YORK — Retail stocks ran with the bulls in 2004, but the bears might stir out of hibernation as investors assess the impact of rising interest rates and more difficult year-over-year profit comparisons on the sector.
But for now, it’s time to pop the champagne as the WWD Composite Stock Index finished 2004 with a 4.7 percent gain, which was driven by robust share value gains among the 55 retail stocks in the composite.
Of the 55 retailers in the index, 41 ended the year in the black, while 14 dropped into the red. And of the 41 gainers, 35 retailers closed the year with double-digit increases. The average percent change showed a gain of 32.2 percent.
The big winners include Kmart Holdings Inc., American Eagle and Gottschalks, which had year-end gains of 313.2, 187.2 and 152.6 percent, respectively.
The WWD index was weighed down by a lackluster performance on the supplier side of the composite. As a result, the broader S&P 500 outpaced the WWD index and closed the year with a gain of 9.5 percent.
Early in the year, as the graph shows, the WWD Composite Stock Index outperformed the S&P. This was because investors view retail as an “early cycle” sector, meaning Wall Street was making a bet on the fourth quarter by trading the sector up in the first quarter.
As the year progressed, investors slowly pulled out. By the summer, economic uncertainties such as the jobless recovery, the war in Iraq and the election had investors scrambling for other sectors.
But as it became increasingly clear, based on polling data, that President Bush would be reelected, Wall Street returned to the retail sector with the idea that consumer spending, which drives two-thirds of the economy, would keep its steady pace.
And it did. But not with apparel, which lost ground to expenditures on home goods, health care and fuel. Still, 2004 was a top year for retail stocks.
From here, investors should remain choosy with their retail stock picks as a bevy of factors stand to work against upward price movement, according to analysts.
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Luxury stocks, such as Neiman Marcus and Coach, and certain turnaround plays, such as Nordstrom and Kohl’s, are expected to perform well on the investment thesis that consumers will continue to spend.
Factors working against retail stocks, however, include rising interest rates, difficult first-quarter earnings and monthly sales comparisons, and a fashion environment that stands to involve less outright newness than the first quarter of 2004 when bright colors jolted the market, helping to bring consumers out of their spending doldrums.
Still, with the Dow Jones Industrial Average and S&P 500 approaching 42-month highs, investors have every reason to be optimistic for 2005. If anything, retail stocks in the first quarter of 2005 have a good chance of performing well, according to Bob Buchanan, equity analyst at A.G. Edwards & Sons Inc., who noted that retailers have outperformed the S&P 500 in 11 of the last 13 years. The average first-quarter gain is 5.7 percent for the retail group versus the S&P’s average gain of 1.4 percent.
Paul Nolte, director of investments at Hinsdale Associates, wrote in his latest weekly investment report that consumers have the potential to find new ways to spend this year. “We just cannot count out the consumers, with more tricks up their sleeves than Bullwinkle, this just may, once again, be the year of the consumer,” Nolte said.
The luxury sector stands to benefit once again from what seems to be consumers’ insatiable demand for pricey items. “We do expect high-end retailers to outperform the more moderate players well into 2005 as income growth for the high-end consumer continues to outpace that of the average worker and higher gas prices will continue to pressure spending of low-income households,” wrote Sanford Bernstein & Co. analyst Emme Kozloff in a Monday research report.
For her part, however, Kozloff thinks investors could be in for “a rude awakening” on the performance of retail stocks in the first half of 2005, citing in a Dec. 20 research report quarterly earnings estimates that she thinks are too optimistic. Current forecasts for a 16 percent earnings increase in the first quarter of 2005 seem to ignore the 22 percent earnings growth comparison from the first half of 2004, she said.
“Investors may need to be patient and wait through the downward earnings revisions shakeout in January and February until the stocks look attractive enough,” Kozloff concluded.
In the same vein, Wells Fargo Securities analyst Mark Montagna sees a cooling off of first-quarter stock prices in the specialty retail sector. He thinks investors are apt to worry about difficult sales and earnings comparisons.
Where it gets foggy is how likely rising interest rates will impact this consumer cyclical group. “Historically, a rising interest rate environment has boded poorly for stocks in the retail sector,” wrote Montagna. If rates continue to rise, “it could hinder the profitability of retailers, thereby hindering the performance of their stocks.”
2004 WWD Composite Stock Index Vs. S&P 500
