Jim Jubak

Should you be getting your portfolio ready for Christmas?

If you're like a lot of us, you've noticed that the stocks to own in this rally were things: commodity producers and the companies that made machinery for commodity producers.

Brazilian iron ore miner Vale (VALE.O) was up 23% from its Aug. 26 low to its Oct. 29 close of $32.14. Copper and gold producer Freeport McMoRan (FCX.N) was up 41% in the same period. Mining-equipment-maker Joy Global (JOYG.O) was up 32%.

I'm not urging you to dump those stocks out of your portfolio now. I think they should continue to do well in the fourth quarter as growth in the world's developing economies drives demand for commodities and as a declining U.S. dollar and rising fears of U.S. inflation drive demand for commodity stocks.

But I do think it's time to see how far your portfolio has drifted (like Mae West: "I was Snow White, but I drifted") toward an excessive allocation to a sector that is, whatever its prospects, more expensive than it was two months ago. And to add a few positions in a sector that has been largely overlooked in this rally and that's likely to do surprisingly well this quarter.

I mean retail.

Best of times, worst of times
This is retail's time of year for lots and lots of volatility. The holiday shopping season is the time when retail stocks do really, really badly -- if expectations are high and the results are disappointing. And it's the time when retail stocks do really, really well -- if expectations are low and the results are surprisingly strong.

And that's where I think we are this year. Expectations for the holiday season among investors are really low. Many of them have written off consumers completely, saying they'll never open their wallets again.

But this year's holiday shopping season looks like it will be decent. Sales during the 2009 holiday season rose just 0.4% from the previous year. The current forecast is for 2.3% growth this year over 2009. And the forecast might have some room to run slightly higher.

At the beginning of October, the forecast from the optimists was for a 2% increase this holiday shopping season. (See my post "Growth in retail sales doesn't sound like much, until you compare it to last Christmas.")

The third-quarter report of gross domestic product, released Oct. 28, showed consumer spending growing at a 2.6% rate. (See my post "Third-quarter GDP comes in on projection, unlikely to change Fed's decision next week.")

Nothing here to knock your socks off, but 2% is sure better than 1%, and 2.3% is better than 2%, and 2.6% is . . . well, you know.

Why a little goes a long way
Let me flesh out the argument for adding a retail stock or five to your portfolio this holiday season and give you five names to put under your tree.

I'll start with a little more detailed look at why 2.3% retail sales growth this holiday season is likely to be enough to make holding retail stocks profitable.

I'm going to use Target (TGT.N) as my example, because for most of the past decade it turned in revenue growth that was consistently ahead of the average U.S. retailer. According to Standard & Poor's, from fiscal 2004 to fiscal 2008 (which ended in January 2008), the company showed a compound annual growth rate of 10.6%. That came to a crashing halt in fiscal 2009, when revenue climbed just 2.5%, and in fiscal 2010 (which ended in January 2010), when revenue climbed by a tiny 0.6%.

If you're looking for a return to the glory days of 2004-08 in the fiscal year that ends in January 2011 -- well, forget about it. Standard & Poor's projects sales growth in the single digits for the year.

But even 5% looks good when the past two years have shown 2.5% and 0.6%.

Click graphics to see interactive charts // Target, TGT(Graphical chart for TGT)


Click graphics to see interactive charts // J.C. Penney, JCP(Graphical chart for JCP)

J.C. Penney

Of course, as Target's sales growth for fiscal 2004-08 shows, retailers don't do business in Lake Wobegon, where all the stores are above average. Even if this holiday season is going to be surprisingly strong, some retailers are going to be (or continue to be) unsurprisingly weak. J.C. Penney (JCP.N), for example, is expected to grow same-store sales just 2% in the fiscal year that ends in January 2011, according to S&P. It shouldn't be surprising that Penney will lag Target in fiscal 2011. Penney has been a retail laggard for quite a while. Five-year average annual sales growth at the company is a negative 0.6%. For department stores, the 2004-09 average is 8.3%.

Same goes on the upside. Coach (COH.N), which operates in luxury goods, a different retail segment than Penney or Target, has averaged 16.9% annual sales growth during the past five years, according to Thomson Reuters. That beats the category (apparel, footwear and accessories) average of 11.9% quite handily.

Five to put in your shopping basket
Let's say we want to design a retail portfolio of five stocks. A good mix would include some high-growth momentum retailers like Coach.

These stocks aren't especially cheap, but to investors looking for earnings growth and earnings momentum, these are the stocks to own. You'd also want to add a few lower-price stocks that come with less risk but are well-managed and have a history of finding a way to take advantage of an improved retail climate.

My growth-momentum picks, no surprise, start with Coach. Here's what I like most about the quarterly earnings the company reported Oct. 26. Yes, the 19% revenue growth for the quarter was great, and the international story is just cooking along with eight new stores in China (total now 49) in the quarter.