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Here’s Why Retail Stocks Could Underperform Over the Next Year

Retailers have outperformed in 2021 due to a unique mix of factors. They face some significant challenges in 2020 so investors should consider taking profits or even betting against the sector with this ETF.

One interesting development in 2021 has been the outperformance of retailers who derive the bulk of their revenues from physical stores rather than e-commerce. The best illustration of this dynamic is the ProShares Long Online/Short Stores ETF (CLIX).

CLIX invests in e-commerce companies like Amazon (AMZN), Chewy (CHWY), and Wayfair (W), while it shorts the stocks of retailers who derive the bulk of revenues from physical stores. 

CLIX made its debut in September of last year and soared during the most acute portion of the pandemic. However, since mid-February, it’s given back these gains and is down 30% from its peak as physical retailers have outperformed. 

It’s a stunning turnaround for physical retailers as this group suffered last year due to stores being shut down for parts of the year and many consumers opting to shop online due to concerns about the coronavirus. This only compounded the struggles for many retailers who have underperformed for most of the past decade with many high-profile bankruptcies in the space like Sears and JCPenney. 

Two factors behind their challenges are the decline in foot traffic to retail stores as online sales took a greater share of overall spending and the shrinking middle class. However, the surviving retailers earned a reprieve in 2021 due to a combination of pent-up demand for in-person shopping and stimulus-fueled consumers eager to spend. 

Despite this increase in earnings, I believe that investors should consider selling into this strength. The long-term issues that have plagued this group for the last decade continue to pose significant challenges. Additionally, the outlook for consumer spending for 2022 has deteriorated. Finally, retailers face the same issues as many businesses in terms of a tight labor market and rising costs but don’t necessarily have the ability to pass these onto customers.

Long-Term Challenges

Despite a sharp increase in foot traffic in 2021, longer-term trends are not supportive that this is the beginning of a new resurgence in people shopping at physical locations. The majority of young people prefer to shop and browse for products online and have been accustomed to that experience. 

Further, fulfillment and delivery times of online shopping continue to decrease, in addition to online sales having bigger margins. As a result, retailers have been scrambling to build their online presence and e-commerce sales channels to varying degrees of success. Those that can succeed at this endeavor will be among the companies that survive, while those that fail to do so will likely meet the same fate as JCPenney or Sears. 

Another challenge for retailers is that there was an overbuilding of retail stores over the last couple of decades in anticipation of continued growth that never materialized. Physical stores have massive costs in terms of rent, maintenance, and labor that negatively impact margins.

Outlook for Consumer Spending

One reason that retail did so well in 2021 was that consumers were flush with stimulus money, and they had above-average savings due to so many outlets for spending being unavailable in 2020.

2022 will likely feature a much different sense of circumstances. There will be no stimulus checks, and inflation will certainly eat into some portion of spending due to higher energy, food, and rents. Additionally, some of the pent-up demand that benefitted retailers will also likely be exhausted next year.

Therefore, investors should expect that retailers will feel the brunt of the pain from less discretionary spending in 2021.

Rising Costs

So, while retailers may see less demand than in 2020, they are certain to see higher costs. There is the most wage pressure at the lower end of the spectrum, and retailers tend to hire from this group. They also tend to increase hiring during the holiday season which might also prove to be difficult given the shortage of workers.

Another issue that retailers face is that shipping costs have exponentially increased over the past year. These higher costs will also certainly eat into margins and make it more difficult to ensure that retailers have the hottest selling items on their shelves.

Conclusion

These three factors - rising costs, weakening consumer spending, and the sector’s long-term struggles - mean that investors should be cautious when looking at retail stocks and not be seduced by last year’s stellar results. 

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AMZN shares were trading at $3,361.33 per share on Monday morning, down $101.19 (-2.92%). Year-to-date, AMZN has gained 3.21%, versus a 16.89% rise in the benchmark S&P 500 index during the same period.



About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles.

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