Playing The Lipstick Effect

By Aaron Levitt | June 19, 2012 AAA

With the global economy on shaky ground, American consumers have once again begun to retreat. Issues from Europe's continuing debt debacle to the recent poor jobs report has sent consumer confidence downwards to levels not seen since January of this year. Industry group, The Conference Board recently reported its latest index of consumer attitudes had fallen to 64.9 from the previous months' 68.7. Analysts had been expecting a gain to 70. To that end, investors have once again fled from discretionary names and funds like the First Trust Consumer Discretionary AlphaDEX ETF (ARCA:FXD). However, not all of the consumer discretionary names should be thrown away. For those firms who operate in the near-luxury sector, the time could be right to buy.
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Upgrading Your Lipstick
With the consumers in the United States once again feeling glum about their prospects, now could be good time to bet on the aspirational or accessible luxury brand purveyors. Analysts point to an economic indicator called the "lipstick effect." The theory, which has been proven almost true with every economic recession, basically states that when economic times are tough, consumers stop spending on big ticket items, and actually increase their spending on smaller indulgences. Consumers can't or don't want to purchase new homes, cars and the like when they're unsure about their financial security. However, the same consumers turn to less expensive extravagances, such as lipstick, when they feel less than confident about the future. People don't want to feel deprived, so they seek solace in smaller "treats."

As consumer confidence numbers have drifted lower, analysts expect the lipstick effect to once again make itself known. Already, some near-luxury brands Steven Madden (Nasdaq:SHOO) have reported better than expected earnings in the difficult consumer environment. All of this means that now may be the time for investors to pounce on stocks that own accessible luxury brands. Less affluent individuals looking for affordable status symbols should increase small luxury spending, while those in the upper-ranks may feel compelled to trade "down" in order to save money.

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Adding Some Accessible Luxury to a Portfolio
With the American consumer once again showing some signs of strain, big ticket items may be off the radar for many households. However, many are still finding a way to purchase aspirational or "near-luxury" goods. For investors, betting on these firms makes sense. A good broad play on the theme is the PowerShares S&P SmallCap Consumer Discretionary (Nasdaq:PSCD). The exchange-traded fund (ETF) tracks 107 different firms including, Iconix Brand's (Nasdaq:ICON) and Perry Ellis International (Nasdaq:PERY). However, there are plenty of individual choices as well.

While handbag maker Coach (NYSE:COH) has been the poster child for aspirational branding, the company has recently encountered some fierce competition in the space. Both Michael Kors Holdings (NYSE:KORS) and Vera Bradley (Nasdaq:VRA) recently went public and have seen great results. Kors Holdings recently reported that its net income more than tripled in its fiscal fourth quarter on the back of strong sales, while Vera Bradley saw revenue from its own stores jump more than 34% in its latest quarter. Both firms represent an interesting take on the near-luxury theme.

Given that the economic indicator is called the "lipstick effect," investors may want do just that and stick with beauty products. Both Revlon (NYSE:REV) and Estee Lauder (NYSE:EL) make compelling buys as consumers trade up to "higher level" personal products. Likewise, fragrance firm Elizabeth Arden Inc. (Nasdaq:RDEN) recently purchased the global licenses for Ed Hardy, True Religion and BCBG Max Azria fragrance brands. All three firms could see higher sales as the lipstick effect takes hold in the upcoming months.

The Bottom Line
With consumer confidence once again in the dumps, analysts predict that the lipstick effect will come back with a vengeance. For investors, that means loading up on aspirational or near-luxury brands. Companies that market these affordable status symbols will be the catalysts for growth in the sector. The previous ideas, along with watch producer Movado (NYSE:MOV), make ideal selections to play the economic effect.

At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

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