In a year when the S&P 500 has risen by nearly 30%, it’s hard to lose money. But it’s easy to do if you don’t identify trends, or if you identify them and try to be contrarian. This is probably clearest in the retail sector, where long-short strategies yielded enormous payoffs for those who identified the right companies to long and short.
Before I delve into that, though, let’s first acknowledge that the S&P Retail ETF (XRT) is up 40% YTD, including a small dividend. You can see the stock’s holdings here, which are an expectedly diverse mix of various retail names, with only one stock, Rite Aid (RAD) representing over 1.5% of the fund’s total holdings. The other top holdings have made a lot of headlines in 2013, and have generally been good stocks to hold, thus explaining why the ETF is outperforming the S&P 500.
So how can a money manager outperform XRT? The key is in this chart:
Click on image to zoom
Here I have singled out one slice of the retail sector: teen-focused fashion, which has done incredibly badly this year, especially in the second half. In the summer, investors suddenly saw that teens weren’t buying these brands anymore, for reasons that are often debated and never understood. Needless to say, some teen brands are doing much better than others; PSUN has more than doubled and GPS is holding strong, thanks to robust Old Navy sales in particular. ARO, ANF, and AEO are doing just awful. This week, ARO and AEO both reported declining same-store sales and disappointing forward outlooks, causing some recent dips after an already miserable year.
A long-short fashion strategy could easily outperform XRT—if the analyst had a keen fashion sense and an understanding of what kids are interested in. How one does this is difficult, but not impossible; indeed, identifying changes in a particular sector of the economy is considered proprietary and highly valuable knowledge within the finance world. While learning how to model companies and create DCFs is the bread and butter of finance, knowing the industry is the frosting that can make returns much sweeter.
Today, ARO and AEO bears are rejoicing in their fashionable investing strategy, while the longs are struggling to adjust with the fastly changing world of retail. In the future, those investors who identify the potential for these names to make a turnaround—or for GPS, PSU, and NKE to maybe lose their appeal in the apparel world—more profits await.