Shopping bags

Call #1: Maintain Underweight US Retailers

Last week, the main monthly gauge for manufacturing activity and May’s non-farm payroll report both came in weaker-than-expected and both confirmed that the economy is experiencing a dramatic slowdown. While we don’t expect a full blown recession, we do now expect weaker growth than the market in coming quarters.

As a result, our calls this week focus on the investment implications of the economic recovery continuing to lose steam.

One of the groups that we believe is most vulnerable to the slowdown is the consumer discretionary sector, and more specifically US retailers. We first highlighted the negative case for retailers back in late December and then reiterated it in March. Since then, US retailers have trailed the broader market by approximately 300 basis points and we are still advocating an underweight to this group.

Starting with valuation, the retail group is now trading at a 25% premium to the broader market. In addition, retailers appear relatively expensive at a time when the US consumer is facing a number of challenges.

First, for low end consumers, hourly wages are not keeping up with inflation. Currently, hourly earnings are growing at around 2% a year, well below the inflation rate. In addition, transfer payments – otherwise known as government subsidies – are decelerating. This is important as transfer payments have been one of the key engines of income growth over the past several years. If transfer payments slow coincident to weak wage growth, middle and lower end consumers are likely to get squeezed, particularly with food and energy prices still elevated.

The bottom line: With the possible exception of very high end consumers, consumption is likely to continue to slow with the economy. Retail stocks are not priced for this slowdown, and if anything appear expensive relative to the broader market. We therefore maintain our underweight view of this group

Call #2: Neutral Emerging Market Bonds

The other implication of a slower global economy is that bonds should do better relative to stocks. Given what appears to be a case of extreme over valuation, we would still advocate a negative view on US Treasuries, but we are now changing our view of emerging market bonds from negative to a neutral stance.

We first advocated an underweight to emerging-market bonds back in mid-November. Since then, emerging market bonds have lost around 2%, underperforming the Barclays Aggregate index. In addition, the slowing global economy should help alleviate inflationary pressure in emerging markets and there is a likelihood of more volatility this summer, further backing up the case for a neutral stance. While we are moving our view of emerging market bonds to neutral, we still advocate an underweight to emerging market stocks.

Potential iShares solutions

Underweight US Retailers IYK – iShares Dow Jones U.S. Consumer Goods Sector Index Fund (click here for fund details)
Neutral Emerging Market Bonds EMB – JPMorgan USD Emerging Markets Bond Fund (click here for fund details)


In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.  Narrowly focused investments typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise.

The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Dow Jones Trademark Holdings, LLC or JPMorgan Chase & Co.  Neither of these companies make any representation regarding the advisability of investing in the Funds. Neither SEI, nor BlackRock Institutional Trust Company, N.A., nor any of their affiliates, are affiliated with the companies listed above.