Investment outlook for the retail sector

Peter McLoughlin, fund manager at Santander Asset Management UK says: “Reading the national press or watching the evening news one would picture a high street in the depths of a major recession as consumers, already faced with rising energy, loan and mortgage costs, shy away from parting with what little income they have left.

“In fact the opposite has happened as consumers have, thus far at least, shown a greater resilience to rate rises than was being forecasted earlier this year. This resilience can be attributable to a number of factors but in particular a low unemployment rate and until the last month or so the strength of the UK housing market. The other is that real incomes are still rising.

“History tells us that the sector generally under performs over the Christmas period. While the past is no guide to the future, it is a lesson we ignore at our peril. The fundamental outlook is challenging, and despite the valuation risk being much reduced I remain quite bearish on the outlook for Q1 2008. This is driven by my view that consumers are likely to tighten their belts leading to forecast downgrades and a further de-rating of the sector despite the recent sell off since May 2007.

“The outlook for the UK housing market in 2008 is at best of lower turnover, and the most exposed stocks - mainly DIY, electricals and homeware - are likely to experience the biggest challenges. Therefore I remain wary of big ticket retailers particularly those with high operational gearing. Consumer confidence has yet to wane, being largely unchanged since August 2006, though components of the index have started to deteriorate in recent weeks particularly in those areas of the market at the discretionary end.

“Not to be too despondent, I am warming to two areas of the sector where we could benefit from an easing in monetary policy. The market is likely to give credit to those companies that have adopted an element of self help and those with quality management teams with good organic growth opportunities.”