Retailers on a roll but storm clouds looming

EVEN the worst recession for at least 60 years hasn’t been able to stop the British consumer from flashing the plastic. Snowfall might have deterred the less hardened shoppers from hitting the January sales with full force, but statistics out last week showed we returned to the high street in our droves last month.

Retail sales jumped 2.1 per cent in February, which almost wiped out the 2.5 per cent decline in January and was the biggest monthly gain since May 2008, handily beating estimates of a 0.7 per cent rise. And in case you were thinking that all our pounds have been filling the coffers of Tesco and J Sainsbury, non-food store sales rose 3.4 per cent compared to the 1.2 per cent drop in food store sales.

Company news also added to the optimism. Clothes retailer Next reported an 18 per cent jump in full-year pre-tax profits on Thursday. Clinton Cards and Ted Baker also reported higher profits, while Kingfisher raised its dividend for the first time in five years.

But while the markets cheered – even sterling managed a bounce – there are still plenty of clouds on the horizon that contain far worse than snow for the sector. Spread betters taking a view on the retail sector should be cautious for two reasons.

First, the uncertainty surrounding the election and how the next government will seek to repair the fiscal deficit. If the next government instigates tax hikes and public spending cuts such as slashing jobs, then discretionary spending will fall, with a detrimental impact on retailers.

Second, the Bank of England is expected to tighten policy this year by about 50 basis points. But with significant tightening not pencilled in until next year, the full impact will only be felt by the high street in 2011, says Sam Hart, analyst at Charles Stanley.

With consumer spending expected to strengthen as the outlook for unemployment improves, a short-term bullish punt on the retailers could be justified. Just put in some fairly close stops and keep an eye on what the government is up to. It might be worth taking profits off the table ahead of relevant data and the general election.

Next, for example, is rated as a “Buy” by many analysts despite a share price which has risen 20 per cent over the past six months. Hart points to the company’s good management and cash generation ability and says he wouldn’t call the top in the stock just yet. It is trading on a price-to-earnings ratio of 10.1 times, roughly in line with the wider sector.

Luxury retailer Burberry is good for spread betters looking for international exposure. The firm has moved into emerging markets, which thanks to their stronger growth and burgeoning middle class, should be a key driver of profits for the company in the months ahead.

Spread betters can take a punt on stocks but they may wish to either hedge their position or supplement it with a bet on the sector. You could go long on Next to benefit from further outperformance, but short the sector to protect your portfolio.

But with plenty of uncertainty still to come, spread betters will have to be prepared to jump out of their positions quickly and reverse should the economy take another turn for the worse or the government cranks the screws tighter.