A Pair Trade For A Changing Consumer Landscape

Establishing a paired trade is not only an assertion of relative strength, it manages beta. In the current environment, an ongoing bear market, growth premiums have come back to earth while earnings premiums have not. In other words, stocks with a major growth component have been punished while those valued more traditionally have not. Maintaining a neutral stance while gaining upside exposure in case a bottom is in seems prudent.

Going long high beta paired with short low beta allows for hedged upside exposure. Furthermore, higher beta stocks are often nimble leaders while lower beta names lag. Today, establishing a paired trade appears to be the lowest hanging fruit.

Diminished savings has made headlines recently. Covid relief coffers have gone dry and the effects of inflation are crippling savings rates. Many consumer discretionary names in travel and entertainment have been hammered in the last year. Conversely, consumer staples such as utilities and groceries have been among the market’s few safe havens.

While travel and entertainment are clearly more discretionary, restaurants and clothing stores are simply not consumer staples. Their valuations are stretched and the market is failing to price in a paradigm shift in discretionary spending that is well underway. Investors as a group see McDonald’s (MCD), Burger King (QSR), Ross Stores (NASDAQ:ROST) and TJX Companies Inc (TJX) as staples when, in fact, these companies depend greatly on society’s most fragile excesses. High net worth individuals will likely spend more at TJX, QSR and the like in 2023 than they did in 2022 as price consciousness rises from the ashes. Unfortunately, hundreds of millions of other consumers will spend much less. When layoffs, currently limited to the top of the food chain, make their way to the masses, these pseudo-staples will incur the greatest damage. Bloomberg indicates this phenomenon is occurring in Europe as well.

Conversely, LVMH (OTCPK:LVMHF) sells luxury goods to a decidedly affluent customer base. Its brands have a global appeal that make it relatively immune to challenges specific to the stereotypical American Consumer. McDonalds, too, has a global presence, making it the least appealing short candidate of the pseudo staples.

Long LVMH, short ROST based on relative strength and valuation is my preferred trade here. A higher beta alternative would be pairing a short position in any of the pseudo staples with a long in QQQ, particularly using options.

ROST has traded down in January each of the last 3 years, currently sits 10% below it’s all time high, with a P/E ratio over 28x and dividend yield of 1.07%. LVMH trades approximately 15% off highs reached in 2021, with a P/E just under 26x and yield of 1.74%.

Initial targets, time frame 2-8 weeks:

Buy LVMH ADR $145. Sell target $160, stop loss $140.

Sell ROST $116. Cover target $95, stop loss $121

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.