Gap (NYSE: GPS) cutting its full-year outlook on higher sourcing costs was set to pressure exchange traded funds that invest in retail and consumer stocks, which have been building momentum lately.

“Management expects product unit costs to be up about 20% in the back half of 2011, and that inflation will likely completely offset any price increases, more dramatically for the value brands such as Old Navy and Outlet,” said BMO Capital Markets in a note Friday. “This confirms our view that Gap lacks the pricing power to offset mounting input costs.”

Gap shares fell 15% in after-hours trading Thursday after the company reported quarterly results and slashed its full-year profit forecast to a range of $1.40 to $1.50 a share, compared with its previous estimate between $1.88 and $1.93 a share.

“With weak sales trends, ongoing management/strategy changes and inconsistent consumer behavior, we do not expect Gap to overcome the sourcing headwinds in the second half of 2011 easily,” added Jefferies analysts.

The stock accounts for more than 3% of Retail HOLDRS (AMEX: RTH) and PowerShares Dynamic Retail (NYSEArca: PMR).

PowerShares Dynamic Retail

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.