Consumer spending is critical when it comes to growth of the U.S. economy. It makes up a significant portion of the U.S. gross domestic product (GDP)—about 70%. So, if consumer spending declines even by a little, it can really impact the trajectory of the U.S. economy.
Since late last year, there's growing evidence that suggests consumer spending is in jeopardy. The economic data that tells the level of enthusiasm among American consumers is flashing warning signs. Investors who own retail stocks need to be very careful.
For example, retail sales in the U.S. economy declined 0.4% in January from the previous month. But this isn't the only troubling news. The previous reported number—the change in retail sales from November to December—was revised lower from 0.2% to negative 0.1%. (Source: "Advance Monthly Sales for Retail and Food Services January 2014," U.S. Census Bureau web site, February 13, 2014.)
The U.S. Census Bureau looks at retail sales of about 13 different kinds of businesses. In January, nine of those kinds of businesses—including furniture stores, health care and personal care stores, clothing stores, and sporting goods stores—reported a decline in their sales from the previous month.
Sadly, retail sales aren't the only indicator that suggests consumer spending in the U.S. economy is grim. Other indicators like the U.S. manufacturer and trade inventories say the very same; they increased to $1.7 trillion in December, up 0.5% from November 2013 and 4.4% from the same period a year ago. (Source: "Manufacturing and Trade Inventories and Sales December 2013," U.S. Census Bureau web site, February 13, 2014.)
When inventories increase, it means consumers aren't buying as much. It also says that the companies are just producing and stockpiling their production—which has many consequences as well.
If consumer spending is turning bleak, what should an investor do?
Consumer spending declining can send the U.S. growth rate tumbling down even further. Remember; in 2013, the U.S. GDP actually decelerated compared to 2012. This year, if all the scrutiny in consumer spending continues, it wouldn't be a surprise to see the same.
More specifically, companies that are highly correlated with consumer spending, such as retailers, will face troubles. The reasoning behind this is very simple: if consumers buy less and less, how can retailers' sales, revenues, and profits continue to grow?
Investors can profit from this situation by shorting exchange-traded funds (ETFs) like SPDR S&P Retail ETF (NYSEArca/XRT). This ETF tracks the performance of big-box retailers. Investors can profit even more by shorting companies that sell consumer discretionary products—things consumers don't necessarily need.
Investors who are unfamiliar with shorting may look to buy an ETF like Utilities Select Sector SPDR (NYSEArca/XLU). This ETF tracks the performance of utilities companies, which provide things that consumers actually need, such as electricity. Utilities companies are considered safer companies when consumer spending is in jeopardy.
This article How to Profit When Consumer Spending Is in Jeopardy by Mohammad Zulfiqar, BA was originally published at Daily Gains Letter.