Investors need to bear in mind that the new tax year will usher in further pain for consumers and consumer companies' profit margins may yet be squeezed further, warns Colin McLean of SVM Asset Management.

In supermarkets and general retailers, clothing and other non-food sales are weak, and profit margins are being squeezed, he says - a situation which begs the question of whether shares of UK-focused consumer businesses should still be in clients’ portfolios.

Firms are dealing with the consumer squeeze in different ways, says McLean: Tesco and Marks & Spencer are responding to the UK’s problems by accelerating expansion overseas, the former in California and Nevada, and the latter in Paris and Shanghai. However, he warns that it remains to be seen how successful these strategies really are and that there is danger in UK retailers moving into new areas in the search for growth.

The increased constraints on consumer spending mean that firms will have to quickly adapt – and here those with strong management will be at an advantage.

“Well-managed general retailing chains such as Next and Marks & Spencer should be able to adapt to the new consumer environment. This will involve not just cutting costs where possible, but astute use of branding and market positioning. If investors have held these shares for several years, they should not expect the current weak economy to de-rail these businesses,” said McLean, adding that for the largest retail groups, the risks may be more subtle, such as moves into unproven areas in a search for growth.

He points out that within the consumer spending slowdown story there are sectors which are holding up better than others, such as hotels and restaurants. Another tip is retailers at the lower end of the price scale which are well-positioned to gain market share, such as Lidl and Primark. 

The coming days will see several retailers issue profit updates and many firm’s share prices appear to have already priced in the gloom, notes McLean, pointing out that shares in Marks & Spencer’s jumped 4 per cent on its update as short positions were closed. Shares have fallen so far and so fast in some retailers, that short term rebounds are possible, he says.

“However, investors need to focus on businesses with proven management and good balance sheets.   There is value in the sector, particularly in the major chains with diversified offerings. But, with the likelihood of further cost rises and demand weakness this year, investors in the retail sector will need strong nerves in the short term,” said McLean.