Retail stocks search for direction as rates stay high

By David Randall and Lewis Krauskopf

NEW YORK (Reuters) - Elevated U.S. interest rates are pressuring the U.S. retail sector, where shares of many companies have been dented by months of tight monetary policy while a select few have soared.

The S&P 500 Consumer Discretionary Distribution & Retail index is up nearly 14% this year, roughly keeping pace with the S&P 500’s year-to-date gain. Much of the sector’s strength, however, has been concentrated in a small group of stocks, including heavyweight Amazon.com, which is up nearly 21% this year.

Meanwhile, shares of companies focused on lower-income consumers have struggled, in-part because buyers in that segment have been more affected by elevated interest rates, analysts said. Among the biggest laggards are shares of Dollar Tree, which are down nearly 27% year-to-date and Dollar General, which have fallen nearly 9%.

The retail sector is one of several areas of the economy - in addition to real estate and consumer staples - that have been pressured by elevated rates. The Federal Reserve earlier this week reiterated that it needs to see more evidence of cooling inflation before lowering borrowing costs.

"The lower to mid-income segment is getting squeezed because of gas prices and groceries," said Greg Halter, director of research at Carnegie Investment Counsel. “They feel bad even though the economy is doing well.”

The consumer will be in focus next week when the U.S. reports retail sales data on Tuesday. Analysts polled by Reuters expect retail sales to have grown by 0.2% in May. Weaker-than-expected results - following data earlier this week showing encouraging progress on inflation - could bolster the case for the Fed to ease rates sooner rather than later.

Futures markets have reflected increased investor expectations of a September rate cut, though the Fed projected it will only lower borrowing costs in December.

The divergent performance of retail stocks has pushed investors to focus on companies whose consumers can continue to withstand higher interest rates or those that offer discounts on name-brand household items like clothing or groceries, such as warehouse club company Costco Wholesale.

Halter’s fund has been buying shares of companies such as Walmart, Costco, and TJX Companies whose business models emphasize value for the consumer. Their shares are up 28%, 29% and 16% respectively.

Robert Pavlik, senior portfolio manager at Dakota Wealth Management, said he has owned Costco and TJX Companies, pointing to their strong management and inventory controls.

"I think inflation will remain but moderate and consumers will still look to get the most out of their dollars," he said.

Bokeh Capital Partners owns shares of Urban Outfitters, which are up over 20% this year. Kim Forrest, Bokeh's chief investment officer, said Urban Outfitters' strength as a fashion merchandiser has helped the company weather the inflationary environment, adding "people will sacrifice to look good."

Josh Cummings, a portfolio manager at Janus Henderson Investors, believes areas such as online shopping will continue to thrive even if interest rates stay elevated.

He has been targeting companies such as Carvana, whose shares have nearly doubled this year, and DoorDash, whose shares are up around 13%.

"We're not terribly excited about the consumer sector overall, but we do think we are in the early innings of some of these growth stories," he said.

(Reporting by David Randall, Editing by Nick Zieminski)