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Capitalize on Holiday Spending

By Benjamin Shepherd on December 21, 2011

With the holidays upon us–Hanukkah began yesterday and Christmas is just four days away–I want to wish you a safe and happy holiday season. I hope you all enjoy quality time with your family and friends and have the opportunity to relax before the New Year.

Retailers are also hoping for a happy holiday.

The National Retail Federation is certainly feeling cheerier. Over Thanksgiving weekend, shoppers spent a record $52.4 billion, as retailers offered deep discounts and longer operating hours. Because of better-than-expected spending over Thanksgiving, the retail industry’s trade group this month boosted its forecast for holiday sales growth to 3.8 percent from 2.8 percent. That growth is well in excess of 10-year average sales growth of 2.6 percent and pushes total holiday spending to a record $469 billion. Higher sales have also increased port traffic by 0.3 percent in December.

That growth rate is significantly slower than last year’s 5.2 percent jump in spending. But if the forecast holds true, retailers will breathe a sigh of relief; retailers largely depend on fourth-quarter consumer spending to meet their revenue targets. The fourth quarter is make-or-break time for retailers.

But retailers are paying for this growth; the average gross margin for S&P 500 retailers fell by almost 1 percentage point to 32.2 percent in the third quarter, largely due to steep discounts.

A lower unemployment rate and an improved economic outlook are certainly helping holiday sales. But a sizeable bump in spending isn’t a sure thing. Income growth remains stagnant and foot traffic in shopping malls is off by more than 2 percent compared to last year. Online retailers such as (NSDQ: AMZN) are also pressuring brick-and-mortar retailers with free shipping and deep discounts.

SPDR S&P Retail ETF (NYSE: XRT) is a passive retail exchange-traded fund (ETF) that tracks a basket of 96 retail stocks trading on the NYSE, AMEX or NASDAQ exchanges. The fund uses a modified equal-weighted index that deemphasizes large-cap companies–which account for just 12.7 percent of assets. The ETF also has large allocations to mid-cap and small-cap retailers, which account for about two-thirds of assets. Only 11.9 percent of assets are allocated to the fund’s top-10 holdings.

The fund’s portfolio is well diversified across various subsectors of the retail space. Although the ETF has a heavy allocation to apparel retailers (about 30 percent of assets), it has healthy allocations to grocery stores, automotive outfits and electronics retailers. It also allocated about 5 percent of assets to online retailers.

The fund is the largest retail-focused ETF, with more than $641 million in assets and almost 100 individual holdings. It is also the cheapest retail-focused ETF, with an expense ratio of 0.35 percent.

PowerShares Dynamic Retail Portfolio (NYSE: PMR) employs a quantitative strategy that factors in growth, valuation and risk-based metrics in the construction of its portfolio. The fund’s portfolio is concentrated with 29 holdings and almost half of the ETF’s assets are held in the fund’s top-10 positions.

However, PowerShares Dynamic Retail Portfolio is more balanced in terms of market capitalization, with 40.3 percent of assets allocated to large caps, almost 20 percent in mid-cap stocks and 32.6 percent of assets held in small-cap names.

PowerShares Dynamic Retail Portfolio is much smaller than SPDR S&P Retail ETF, with just $29.6 million in assets. It’s also more expensive, with an annual expense ratio of 0.63 percent.

Investors seeking to invest in retailers during this holiday season would be better off with SPDR S&P Retail ETF. Although I don’t expect stellar retail sales this season, they should surprise to the upside. When retailers perform better than expected, SPDR S&P Retail ETF tends to outperform PowerShares Dynamic Retail Portfolio because the latter places a greater emphasis on controlling downside risk.

Nevertheless, I would approach the sector with caution.

What’s New

Royal Bank of Scotland launched RBS NASDAQ-100 Trendpilot ETN (NYSE: TNDQ) last week, its sixth fund in the Trendpilot family.

The exchange-traded note (ETN) employs a simple momentum-based strategy, tracking the NASDAQ 100 Total Return index after it closes above its 100-day simple moving average for five straight days. When the trend is broken, the ETN tracks 90-day Treasury bills.

The fund uses a hybrid expense structure, charging 1 percent when it tracks the NASDAQ 100 and 0.5 percent when it tracks Treasuries.

That pricing structure is costly when one considers that PowerShares QQQ (NSDQ: QQQ), which tracks the NASDAQ-100, charges just 0.2 percent in expenses. Meanwhile, iShares Barclays Short Treasury Bond (NYSE: SHV) charges an expense ratio of only 0.15 percent. In the case of RBS NASDAQ-100 Trendpilot ETN, you’re mainly paying for convenience.

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