PowerShares Dynamic Retail ETF Finds Bargains in Discount Retailers

Despite an extended economic slowdown and poor consumer spending numbers, PowerShares Dynamic Retail Portfolio ETF (PMR) gained momentum over the summer. While some analysts believe that the worst is yet to come for retail, an increasing number of investors believe that some retailers are oversold and that these names are now at bargain prices. While much of the retail news remains gloomy, PMR’s year-to-date returns are in positive territory—up 1.21% year to date as of August 27 in the midst of a difficult economy.

PMR remained stagnant in our Sector Momentum Rankings for much of June and July but has made significant gains in recent weeks, jumping in our rankings from No. 32 on July 30 to the No. 14 position on August 27. PMR’s returns have made significant gains during the last month, due to a combination of portfolio composition, sector news and timing that boosted the fund 5.59% for the month ending August 27.

The retail sector has suffered some of the hardest blows from an almost universally difficult economy. The latest retail numbers, released August 29, show personal income lagging 0.07% while real disposable income fell 1.7%. While the latest statistics may have a very immediate impact on the price of some retailers, many analysts are predicting that price cuts could affect some retailers in a more resounding fashion. Long-term effects of deep discounting could include damage to some brand names, while consumers who become accustomed to current discounts might resist a “return to normal” price shift in a better economy.

Gas prices and general market malaise have certainly curbed retail equity prices to various extremes. While it may be too early for some investors to sample the retail market, current conditions may provide excellent opportunities for those willing to bet that retail is oversold—and that holiday consumer spending will be better than expected. PMR may be the perfect vehicle for the cautiously optimistic—incorporating large consumer names into its pool of components while using a conservative method to evaluate them.

PMR tracks PowerShares’ Retail Intellidex. Candidates of the index are evaluated on a range of criteria, including fundamental growth, stock valuation, investment timeliness and risk factors. PMR, then, comprises those securities that show the greatest capital appreciation potential as measured by the index. As of August 2, the resulting index includes 30 equities that are dispersed throughout the market-cap spectrum—with an emphasis on large-cap growth and value.

The harsh reality that faces the retail sector—consumers with fewer dollars to spend—may be a boon for PMR’s investors. With fewer dollars to spend, many consumers have inevitably turned to discount stores in an effort to cut costs. PMR’s top 10 components include TJX (TJX) and Wal-Mart (WMT), a combination that could continue to prosper with a shift in consumer spending to discount venues.

PMR’s largest holding is TJX Companies, with a relatively modest 5.62% of the portfolio. TJX is the parent company of discount retailers such as T.J. Maxx, Marshalls, A.J. Wright and Bob’s Stores in the U.S. and Canada and specializes in off-price family apparel and home fashions. As discretionary income continues to fall, discount retail centers could attract more patronage during the holidays as consumers pare back spending without sacrificing the allure of brand-name items. As of September 2, TJX’s market cap had grown to more than $15 billion in 2008—an increase of more than 22% year to date.

Wal-Mart—PMR’s fourth-largest component has also benefited from the discount rush. As September’s first trading day commenced, Wal-Mart had the highest year-to-date performance among the Dow’s 30 components. Wal-Mart’s 27.5% year-to-date return led IBM (IBM), the next highest gainer, by an impressive 14% as of September 2. Wal-Mart’s strength could gain an additional boost from Thursday’s same-store sales results, which are expected to confirm price disparity between low-priced retail stores—like Wal-Mart—and their mall-based competitors.

In addition to capturing gains from discount retailers, PMR has also benefited from two rental-based retailers—Aaron Rents Inc. (RNT) and Rent-A-Center (RCII)—that are both positioned in PMR’s top 20 holdings. A drop in consumer spending has benefited the rental business, and RNT and RCII have seen gains of 48.56% and 56.06% year to date, respectively, despite the economic slowdown. Together, RNT and RCII cover a broad range of consumer goods—from flat-screen televisions to furniture—that consumers may prefer to rent, rather than purchase, as spending decreases.

While retail may remain a sore spot for investors in the coming months, PMR could present a good opportunity for those who believe that the retail sector will continue to shift as consumers reallocate their spending. With a combination of discount and rental stores, PMR’s momentum may continue to pick up steam as the holiday season approaches. Whether investors watch from the sidelines or inside the pack, PMR’s surge in momentum could be an interesting—and perhaps profitable—trend to track.