Q2 Outlook For Retail ETFs

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Includes: PMR, RTH, XRT
by: Zacks Funds

Retailing involves buying large quantities of goods and selling them in smaller quantities to consumers for a profit. The health of the retail industry is an important economic indicator, as it is linked directly to consumers and their propensity to spend. Consumer spending is the key to the well-being of any economy, as it accounts for more than two-thirds of economic activity.

The link between consumer spending and the retail industry becomes more relevant, as retail sales attract approximately 30% of total consumer spending in the U.S. Also, the retail industry ranks among the top U.S. industries and employs an enormous workforce, contributing to the health of the job market.

Before jumping onto the trends in retail, here's a peek into the key economic indicators, which suggests where the market is heading.

Recent data revealed that U.S. consumer spending rose a marginal 0.1% in February 2016, following a revised January 0.1% rate of increase, which was previously reported at a 0.5% increase. Adjusted for inflation, consumer spending rose 0.2%. This slowdown in consumer spending has lowered the predictions for economic growth in the first quarter of 2016. We note that income rose by a modest 0.2% in February, after a 0.5% increase in January, which marked the strongest income growth in seven months. Analysts suggest that the slowdown in incomes is rather temporary amid a tightening job market that is driving wages higher.

Despite this recent weakness, market pundits still expect consumer spending to pick up as the year passes, as the improvement in employment levels will likely drive up incomes and ultimately encourage consumers to spend.

Concurrently, a report by the Commerce Department suggests that the third estimate of real gross domestic product (GDP) expanded at an annual rate of 1.4% for the fourth quarter of 2015, above the second estimate of 1%. Also, according to the report, real GDP for 2015 rose 2.4%, at the same rate as for 2014. These reports collectively advocate that the U.S. economy is definitely showing resilience, while keeping rumors of an upcoming recession at bay.

Seconding these views, we note that the U.S labor market looks quite stable, with unemployment rate for March standing slightly up from last month at 5%. The report by the Bureau of Labor Statistics indicated that a total of 215,000 nonfarm payroll was added in March, of which retail employment increased 48,000.

Given a rebounding U.S. economy, the retail space is bubbling with optimism. This is evident from March's 0.5% rise in retail sales, excluding automobiles, gasoline stations and restaurants, from February 2016, as reported by the nation's largest retail trade group - National Retail Federation (NRF). The federation pointed out that the growth in March came despite the uncertain global economic outlook and challenges in the industrial and financial sectors. Sales for the month benefited from an early Easter that increased retailers' sales, as well as steady improvements in labor market and increased incomes that determine consumers' spending appetite.

As reported in February, NRF projects retail sales in 2016 to rise 3.1%, which is higher than the 10-year average sales growth of 2.7%. Online sales in 2016 are expected to increase in the band of 6-9%.

Market experts expect retail sales growth in 2016 to come on the back of improving wages, new job creations as well as steady consumer confidence, which will negate the headwinds from an uncertain global environment, particularly the economic slowdown and financial mayhem in China, the strong U.S. dollar and persistent problems in the energy sector.

Playing the Sector through ETFs

ETFs present a low-cost and convenient way to get a diversified exposure to this sector. Below, we have highlighted a few ETFs tracking the industry:

SPDR S&P Retail ETF (NYSEARCA:XRT)

Launched in June 2006, the SPDR S&P Retail ETF is a fund that seeks investment results corresponding to the S&P Retail Select Industry Index. It consists of 98 stocks, the top holdings being Office Depot Inc. (NYSE:ODP), Fresh Market Inc. (NASDAQ:TFM) and Children's Place Inc. (NASDAQ:PLCE), representing asset allocation of 1.56%, 1.36% and 1.32%, respectively, as of April 1, 2016. The fund's gross expense ratio is 0.35%, while its dividend yield is 1.17%. XRT has $632.14 million of assets under management (AUM) as of April 1, 2016.

Market Vectors Retail ETF (NYSEARCA:RTH)

Initiated in December 2011, the Market Vectors Retail ETF tracks the performance of Market Vectors US Listed Retail 25 Index. It comprises 26 stocks, the top holdings being Amazon.com Inc. (NASDAQ:AMZN), Home Depot Inc. (NYSE:HD) and Wal-Mart Stores Inc. (NYSE:WMT), representing asset allocation of 13.65%, 8.68% and 7.20%, respectively, as of April 4, 2016. The fund's net expense ratio is 0.35% and its dividend yield is 2.25%. RTH has managed to attract $141.5 million in AUM as of April 4, 2016.

PowerShares Dynamic Retail Portfolio ETF (NYSEARCA:PMR)

The PowerShares Dynamic Retail Portfolio ETF, launched in October 2005, follows the Dynamic Retail Intellidex Index and is made up of 30 stocks that are primarily engaged in operating general merchandise stores, such as department stores, discount stores, warehouse clubs and superstores. Its top holdings are The Walgreens Boots Alliance Inc. (NASDAQ:WBA), CVS Health Corp. (NYSE:CVS) and Home Depot Inc. (HD), reflecting asset allocation of 5.13%, 5.06% and 5.05%, respectively, as of April 4, 2016. The fund's net expense ratio is 0.63%, while its dividend yield is 0.74%. PMR has managed to attract $22.5 million in AUM as of April 4, 2016.

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