About two years ago, I got a great stock tip from my ex-fiance. She doesn’t have a financial background. So, she wasn’t even aware that she was giving me an investment tip.
It was a terrible mistake. I really should have bought the stock.
It’s up more than 370% in the last two years. This amazing performance is a sign that women just love handbags that carry the MK logo. But it’s also a reflection of a much sinister trend … one that affects the whole economy.
On the other end of the spectrum, discount retailers that cater to the low-income consumers are also experiencing tremendous growth. But it’s the retailers servicing the middle class that are in trouble.
And that presents an investment opportunity.
Why the Middle Class is Disappearing
According to the latest data from the Census Bureau, median household income fell for the fifth straight year in 2012 to $51,017, the lowest inflation-adjusted income since 1995. As you can see in the chart below, that’s 9% below its record high of $56,080 set in 1999.
With income dropping and prices for necessities like health care and education on the rise, the typical American family is cutting back.
That explains why business is booming for discount retailers. Their customer base is growing because more people are falling from the middle to the low-income class.
Meanwhile, the rich keep getting richer. The Wall Street Journal recently reported that the average income for the top 1% has jumped 11% over the last decade. That explains why luxury retailers are doing so well.
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The middle class is the one feeling pinched as the U.S. attempts to climb out of the recent financial crisis. Why is this happening?
Things like excessive regulation and policies that favor special interests have contributed to this trend. The Fed’s monetary policy has also played a key role in recent years. Its bond purchase program known as Quantitative Easing (QE) has boosted the price of financial assets, such as stocks and real estate … assets that mostly the rich hold.
Meanwhile, paychecks are simply not keeping up with inflation. In fact, 40% of all U.S. workers are now making less than what a full-time minimum-wage worker made back in 1968, after accounting for inflation.
The result is a growing gap between the rich and the rest. It’s possibly one of the most dangerous and unintended consequences of current monetary policy.
A Unique Way to Profit From This Trend
So, how can you profit from this trend?
I think this is a perfect scenario for a pair trade. This is a market neutral strategy where traders go long one stock and short another in the same industry group.
In this case, you can buy a discount retailer and short a retailer that sells to the middle class. I recommend buying shares of Dollar Tree (DLTR) and shorting shares of troubled retailer J.C. Penney (JCP).
Dollar Tree is a discount retailer that offers merchandise at the fixed price of $1. The company has added 323 stores just in the last 12 months. Sales have grown at a compounded annual growth rate of about 12% over the last five years. And the stock has jumped 550% since 2008.
On the other hand, J.C. Penney, which caters to the middle class, is in deep trouble. Last month, the company announced the closing of 33 stores and 2,000 layoffs. The stock has lost more than 90% of its value since 2007, and many analysts believe the company is heading to bankruptcy.
I believe this discrepancy in performance will continue. Why? Because the American middle class is dying. And this pair trade is a unique way to profit from this trend.