Retail rally grinds to a halt

Retail sales are flouting analysts' forecasts by accelerating, even in the face of the challenging economic climate. They rose by 3.4% in June compared with the same month last year, according to the British Retail Consortium.

The retail sector has even seen a boom in employment. Full-time staff numbers were up by 3.6% in the second quarter of 2010 compared with the same period last year.

Much of this retail growth can be attributed to televisions and merchandise for the World Cup, as well as some big-ticket buying ahead of the VAT hike to 20% due next January.

With 2.5 million people unemployed and 600,000 public sector jobs forecast to go, retailing is bound to be hit soon. But the crucial factor for consumption is interest rates.

Mervyn King, governor of the Bank of England, recently indicated that interest rates will have to be maintained at record low levels while the UK's economic recovery still hangs in the balance. There is even a possibility of a fresh round of quantitative easing to get the economy back on its feet.

Start of the retail decline

However, the retail dream is beginning to unravel. Just a month ago, Halfords, the cycling business, was a darling of the market, which had high hopes for the resilient car maintenance and high-growth cycling markets.

Until the end of July, the majority of traders were buying Halfords shares on any weakness, on the basis that the share had ridden this year's market volatility well and was up 30% over the year.

However, the announcement of a sales decline of 2.1% for the 13 weeks to 2 July has put paid to that. Looking ahead, the management announced that the impact of the government's spending cuts will be felt more keenly in 2011.

That news caused the shares to open 5% lower the following day. At 481p against a 52-week low of 324p, they could have further to fall.

Trading in online supermarket Ocado has been brisk. Its share price now stands at 154p – but at the end of July its offer price was 180p. Its flotation was saved only by Fidelity and Generation Asset Management, which were hauled in to help get the issue away and between them bought nearly half the new shares.

Analysts had calculated that the initial offer price of 200p to 275p per share overvalued the company, so the issue price was dropped to 180p.

After the float, traders sold the shares, which at the end of the first week traded down to 155p. "The majority of trades were sales by those thinking that Ocado would definitely go lower, but it has maintained some poise," says Nick Sproule, head of sales at Tradefair Spreads.

"It is holding up well considering the negative sentiment on the float. "The clients who have got involved are pretty sceptical that a business that has never made a profit can be valued at close to a billion pounds."

More capital will be required before Ocado stands a chance of breaking even. A fair valuation is probably less than £500 million, suggesting a price of about 120p a share.

Limited share trading
"We have seen a cautious year for trading retail shares," says David Jones, chief market strategist at IG Index. "It would be fair to say that is still the case.

With the austerity measures put in place by the new government, such as the VAT hike next year, clients seem more disposed to sell retail shares into strength rather than think there is going to be a resurgence any time soon."

Jones adds: "If someone had a definite view on retailers over the medium term, maybe a smoother way of trading is to look at taking a position on the General Retailers index. 

"This is based on the FTSE 350 retailers index and is a good cross-section of stocks. Our December General Retailers index quote is 1637/1648, down around 7% in the year to date."

Meanwhile, Angus Campbell, head of sales at Capital Spreads, says HMV is a popular share to trade, having been volatile recently.

He comments: "It has declined 40% over the year. But recently its trading figures have been strong, and with much of its competition struggling or disappearing altogether, clients believe the declines in its share price are now over."

This article was originally published in Money Observer - Moneywise's sister publication - in September 2010