3 Stocks to Buy as This Key Sector Slows

Luxury retail is slowing down for the short term, due to stock market volatility, the iffy state of the U.S. economy, and the global fiscal crisis. Just witness the recent downgrade of Nordstrom, Macy’s, and Saks at Citigroup. Deborah Weinswig , Citi’s retail analyst, said they’re part of an “Empty Pockets” theme for the second half.

Weinwsig noted that high-end consumers make up about 50% of U.S. spending, and are likely to get hit by stock markets swings. She pointed out that same-store sales at high-end department stores are down three to four percentage points since April.  At the same time, fatter inventories in the first quarter, and the expense of building online stores and offering free shipping, are putting pressure on margins.

So, stay away from high-end department stores in the short term; but where do you go if you still want to play in the high-end retail segment? Think trade-downs  -- the cliche term for “affordable luxuries” applies here. As we’ve seen since the start of the recession, the rich still go shopping when the going gets tough; they just do it more selectively.

IBISWorld, the market research company, just looked at the market and concluded that the recession has changed consumers, who “have opted for more subdued, conscientious and functional versions of luxury.” That means custom items, cheap-chic, and eco-friendly goods. IBISWorld estimates that those segments will generate more than $1.5 trillion in revenue this year.  

Flash-sale and daily-deal websites are one area IBISWorld has zeroed in on, but making an investment in those areas is difficult. Gilt Groupe’s management has said it wants to go public, but most of the deal activity in this space is going in the other direction. HauteLook was recently bought by Nordstrom, and Rue La La was spun off by eBay to private holding company Kynetic.

This basically leaves the daily deal site Groupon (Nasdaq: GRPN  ) .  Groupon’s IPO has left long faces all around.  It gets one star from the CAPS community and, as was pointed out here, it looks like things are getting worse.

So skip them, and buy Amazon (NYSE: AMZN  ) . After all, it’s eating everyone’s lunch, and it has plumbed the daily-deal space already with investments in LivingSocial. Even rich people buy from Amazon now, and it’s just a matter of finding the items cheaper over there. But as IBISWorld noted, even the wealthy are currently bargain hunters, so price dominance can’t hurt.

Amazon only gets three stars from the CAPS community, mainly due to a tech bubble-like P/E in the triple digits, but the stock is only up 17% for the last year, and it’s off its consensus target of $250 per share.  Buy it if you believe this is the all-time category killer.

Speaking of price dominance, think Costco (NYSE: COST  ) , as opposed to the department stores. Research from Unity Marketing, a consulting firm focused on upscale retail, found it’s the only discounter that attracts more households with incomes over $250,000 a year than households in lower tax brackets. Costco has topped its $91-per-share consensus target, but don’t be surprised if that goalpost gets moved up. The stock has a five-star CAPS rating, its P/E is a relatively modest 25, and it pays dividends.

On the feel-good goods front, Whole Foods (Nasdaq: WFM  ) may have another tailwind, in spite of the “Whole Paycheck” bit. As recent polls have shown, more people are cooking at home rather than going out to eat, and the high net worth foodies have to stock up somewhere.  As Fools recently noted here, Whole Foods is having a good year, with its stock up nearly 60% over the last year, and a P/E that’s a bit rich at 44. But it has strong margins, four stars from the CAPS community, and it’s still off its $100 per share consensus target.

Trade the empty pockets for affordable luxuries with some of these retailers. On the plus side, they’re likely to thrive once things take a turn for the better. There are other great retailers out there, as well, including  The Motley Fool's Top Stock for 2012. It’s our Chief Investment Officer’s favorite pick for this year, and it may become yours too. Just click here to read more about this winner.