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Check Out Retail Stocks for Outperformance in 2013

There is no shortage of doubt about the retail sector.

There’s the constant pressure on brick-and-mortar retailers thanks to the dominance of Amazon (NASDAQ:AMZN) — cleverly described by Matthew Yglesias of Slate as a “charitable organization being run by elements of the investment community for the benefit of consumers” because of its rock-bottom prices and lack of margins.

And even if Amazon wasn’t eating their lunches, there are plenty of specific problems at fallen brands including JCPenney (NYSE:JCP) and Best Buy (NYSE:BBY). Meanwhile, once-loved discounters have been fading in the last six months while the market has rallied nicely — with Dollar General (NYSE:DG) down 9%, Family Dollar (NYSE:FDO) down more than 14% and Dollar Tree (NASDAQ:DLTR) off over 20%.

But hey, you don’t get rich by piling into a crowded trade. So now might be the time to get into retail if you believe the economy will pick up steam later this year and into 2014.

And, in case you missed it, retail stocks actually are performing quite well as a group right now. The SPDR S&P Retail ETF (NYSE:XRT) has outperformed the market since New Year’s and is up 20% in the past 12 months.

So how can you share in this run?

ETFs Avoid Pitfalls

Since there is a host of retail laggards out there like the ones mentioned above, the best way to limit your risk is to go the exchange-traded fund route. The XRT fund is popular, but be warned it is very flexible in its “retail” label. Top holdings include Netflix (NASDAQ:NFLX) — which seems more of a media play — as well as low-margin grocery stores including Supervalu (NYSE:SVU). This added diversification helps spread your risk around, but isn’t as focused on consumer trends as you might think by the name.

If you really want to bank on consumer trend, then a discretionary ETF like the Consumer Discretionary Select Sector SPDR (NYSE:XLY) or the international iShares Global Consumer Discretionary ETF (NYSE:RXI) could be an interesting alternative. Retailers are in here, but both funds also boast automaker, restaurant and housing exposure. The global RXI fund has Toyota (NYSE:TM), Home Depot (NYSE:HD) and McDonald’s (NYSE:MCD) among its top holdings, and XLY has a similar makeup with Ford (NYSE:F), Lowe’s (NYSE:LOW) and Starbucks (NASDAQ:SBUX) among the top 10 positions.

Both of these discretionary funds have lagged the core XRT retail fund in 2013, but could pick up faster if discretionary expenses gather momentum. Get full details on XLY and on XRT via these links to the official SPDR site, and check out RXI here on iShares.

Shopping for Target

Target (NYSE:TGT) is up 20% in the last 12 months and up almost 30% since the summer lows of 2011. While there have been plenty of high-fliers that have lapped these gains, don’t discount this retail giant … especially if this truly is a secular bull market and if employment and spending figures continue to show improvement across this year.

TGT also boasts a 2.4% dividend; not the best on Wall Street, but still better than Treasuries. And while it’s 5% forecast growth this year doesn’t burn down the house, any growth is still better than the alternative. Besides, I think the play is more about a future shift in consumer trends than the current continuation of economic uncertainty and lackluster spending.

The company just reported strong earnings at the end of 2012 as it continues to grow into the food and grocery biz, and it saw big success with discounts to its Red Card credit card holders.

Back in 2010, Target made a decision to stop offering Visa-branded store cards you could swipe at any merchant and return to the old model of department store credit cards that were only good inside that special retailer. It has proven to be a shrewd move — not only as a motivator to get customers into the store with 5%-off deals, but also because management of the credit portfolio is about to be sold to Toronto-Dominion Bank (NYSE:TD), providing a nice pop to Target. The retailer will keep sharing the profits (and of course keep the right to market deals to shoppers), but won’t have to worry with running a growing credit division. This is very smart because it allows management to focus on operating a retail outfit.

Although overall holiday sales were soft, we have known that for a while. Target has lagged the market year-to-date since a Jan. 3 report from the CEO that said “December sales were slightly below our expectations.” I think the lackluster performance is baked in based on a 5% drop since November vs. a 6% gain for the S&P in the same period.

Outside of data and performance, I really like Target’s brand and strategy. Walmart (NYSE:WMT) is too rural and frankly feels cheap to many shoppers, while Target has better geography in suburbs and select urban areas. Also, its one-stop potential mitigates the risk seen by many analysts who wonder whether window shopping and mall walking might never come back — even if the economy does. Couple that with a very robust e-commerce presence, and I think TGT is a low-risk way to play a spending recovery in the next 12 to 18 months.

Of course, there is risk. Continued drag from the payroll tax hike and weak jobs or GDP growth might hold back consumers, the economy and retailers like Target. And specifically for TGT, the forward P/E is a bit high around 13, so the company is at best fairly valued.

But I think the clouds are parting and we could see momentum in retail later this year and into 2014. That would indicate to me it might be time to buy Target, especially if it draws back around earnings in a few weeks.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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