The U.S. retail sector is that segment of the U.S. economy related to consumer purchases at the retail level. In the simplest form, the retail sector consists of Americans buying goods and services at retail establishments…stores. The retail sector accounts for about 10% of U.S. gross domestic product (GDP).

A little stock market bounce-back is a welcome development. We likely won’t see any material new trend develop until second-quarter earnings season begins. Investment risk is still very high, but there is good news out there.

In the continuing story of a strong retail sector, Ralph Lauren Corporation (NYSE/RL) announced excellent financial growth in its fiscal fourth quarter and management also announced a doubling of its quarterly dividend. When I read news like this, it bolsters my view that the U.S. economy is stronger than the marketplace currently thinks. In a consumer-driven economy, what the retail sector reports is very important news.

According to Ralph Lauren, its fiscal fourth-quarter revenues, ended March 31, 2012, grew a solid 14% to $1.6 billion over revenues of $1.4 billion generated in the same quarter last year. The company experienced double-digit sales growth with particular strength at the retail level. Earnings in the latest quarter grew 29% to $94.0 million. For all of fiscal 2012, the company’s revenues grew 21% to $6.9 billion.

The stock market has been awfully kind to Ralph Lauren; the stock has been in a sustained uptrend since 2003. No doubt the doubling of its dividend will attract more institutional ownership. The stock market jumped on the news.

And other companies in the retail sector are experiencing solid sales growth. Macys, Inc. (NYSE/M) and Target Corporation (NYSE/TGT) have been on a stock market tear lately. Companies like Under Armour, Inc. (NYSE/UA), Nike, Inc. (NYSE/NKE), and lululemon athletica inc. (NASDAQ/LULU) have been really strong on the stock market since the beginning of the year.

On balance, I’d have to say that business activity in the retail sector is generally good and that’s a solid vote of confidence for the U.S. economy. Even Harley-Davidson, Inc. (NYSE/HOG) reported a very solid first quarter, saying that motorcycle sales are accelerating. (See Benchmark Stocks Reporting Great Earnings—But the Stock Market Bet on this Already.) In any recession, the first things to drop are non-essential luxury items like “Harleys.” If sales of Harleys are going up with a stronger U.S. dollar, then the world is definitely not falling apart.

I’ll be looking at the retail sector very closely this second-quarter earnings season. A lot of these companies have been stock market leaders for the last couple of years. If corporate visibility from the retail sector is mostly good, then I won’t worry too much about the rest of this year. As soon as management says that retail sector sales are going soft, we have our next recession.

More bad economic news…

U.S. retail sales for April rose at the slowest rate of 2012. While the retail sector was expected to continue its torrid pace of consumer spending increases in 2012, this report proves my theory: lack of a real winter (because of much better than usual weather in January and February) on the east coast this year resulted in consumers going out and doing their spring shopping early.

To get the real picture on consumer spending, we need to remove car sales, filling up at the local gas station, and building materials from the retail sales numbers to get core retail sales. Core retail sales came in at 0.1% in April (source: Department of Commerce), well below the consensus economic forecast of 0.3%.

April core retail sales in the U.S. were at their lowest level since December of 2011—a poor sign for the fragile retail sector.

What was the big soft spot in April retail sales? It was weak sales at the clothing stores and at the department stores that weakened the retail sector considerably for April.

Sales at building materials stores in the retail sector also experienced a weak April. Obviously these areas were affected by the warm weather and Easter being moved up to March this year.

Let’s face the facts…

If economic growth was strong and the economic recovery was really taking shape, retail sales would have been stronger in April. Instead, there is no follow-through to that short burst in real sales earlier in the year.

The main problem, as I’ve cited countless times in these pages, is that real disposable income is not increasing. How can consumer spending, which is 70% of gross domestic product (GDP), grow when people’s real purchasing power is falling?

The Home Depot, Inc. (NYSE/HD), one of the key components of the retail sector, recently reported weaker than expected earnings because, despite a strong February and March due to warm weather, sales fell off more than expected in the month of April.

Do Home Depot’s financial results suggest that consumer spending will be weaker moving forward? I think they do.

With the unemployment rate remaining relatively high and real discretionary spending not rising, strong retail sales reported in February and March of this year were just an anomaly due to the warm weather.

Now that spring is here and the average consumer is worse off than he/she was before the year started, the retail sector will struggle.

Signs of the weakening U.S. economy are evident everywhere I look (see: U.S. Durable Orders Post Biggest Drop in Three Years). Again, consumer spending makes up 70% of U.S. GDP. And if consumers are not spending, GDP growth will suffer.

Michael’s Personal Notes:

When North America was coming out of its financial crisis, we were fortunate that the emerging markets—especially the growth in the Chinese economy and Indian economy—helped provide some of the growth that the world so desperately needed at the time.

A few short years later, with Europe in a recession and the U.S. economy not growing very much at all, the dependence on Asia has changed. The fact is that the Chinese economy and the economy of India are slowing measurably.

In India, manufacturing production in March 2012 fell 4.4% from a year earlier. This slowdown is blamed squarely on the recession in Europe.

What is more alarming is that the “investment indicator of capital goods output,” which measures how future investment in manufacturing is looking, fell 21% in India from last year!

If this is not an economic slowdown, I don’t know what is.

The central bank of India had forecast 7.6% growth for the coming year, but that will have to be taken down significantly in light of these numbers. The central bank of India is looking for ways to stop the economic slowdown, including lowering interest rates.

While not contracting, the Chinese economy is slowing considerably. In April, China’s industrial output slowed to its lowest level since 2009!

In April, the employment level in the manufacturing sector, which is so important to the Chinese economy, fell at the fastest rate since 2009!

The month-over-month increase in industrial output between March and April this year in the Chinese economy was 0.35%, which was the lowest growth rate ever recorded since the index was created decades ago!

In response to the economic slowdown, the People’s Bank of China reduced its banks’ reserve requirements (equivalent to cutting interest rates here in the U.S.) by one-half-of-a-percent. The People’s Bank of China sees further downside risks to the Chinese economy, which means it could cut rates further a month from now.

There is no doubt that the Chinese economy is feeling the effects of the recession in Europe in terms of its exports (as is evident by the industrial and manufacturing numbers). Retail sales in China grew at a slower pace than expected in April, further adding to the evidence of an economic slowdown in the Chinese economy.

While it helped tremendously to have the Chinese economy and Indian economy as great sources of growth when the U.S. financial crisis hit, they will not be there to support the global economy on the next leg of the downturn. (Also see: World Economic Growth Moving From Slowdown to Contraction.)

Where the Market Stands; Where it’s Headed:

Update and reiteration from yesterday…

Last fall, I circulated a report that stated the stock market would start to crash in the U.S. on or about April 13, 2012. It was entitled “Next Market Crash Starts April 13, 2012.”

I was exactly two week early. From the end of April to yesterday, the Dow Jones Industrial Average has collapsed 896 points, or about seven percent.

But we should not be afraid. Money printing will save the day again.

Wednesday of this week, we got news that several members of the Federal Open Market Committee (the Federal Reserve) said that more monetary easing (money printing) may be required. As I have been predicting for months, as soon as the stock market started to pull back, QE3 would be on to the table again.

What a concept. Stock market and economy start to go down; we just print more money to get them both moving again. How long can this process go on for? How long can the Fed fight the natural forces of a secular bull market?

The bear market rally in stocks that started in March of 2009 is getting close to the end of its cycle. I have been warning my readers that the limited upside for the market may not be worth the risk.

What He Said:

The year “2000 was a turning point of consumer confidence in high tech stocks. 2006 will be remembered as the turning point of consumer confidence in the housing market. That means more for-sale signs going up, longer time periods to sell homes, bloated for-sale inventory and eventually lower prices for homes. But this time, the turnaround in consumer confidence will have a bigger impact on the economy. Hold onto your seats, this is going to be a nail biter.” Michael Lombardi in PROFIT CONFIDENTIAL, August 24, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

Technology stocks are in a constant battle for the wallets of consumers in the retail sector. The ecosystem built by Apple Inc. (NASDAQ/AAPL) through its “iOS” (operating system) has been a huge favorite with consumers in the retail sector. This uniform operating system is important for technology stocks, as it provides a consistent experience for consumers. Since the retail sector is so finicky, this consistent experience has generated a lot of support for Apple’s products.

More control over an operating system is important for technology stocks. This allows them to update the software and implement new features as they want, not the whims of other companies. This is what Google Inc. (NASDAQ/GOOG) is attempting to do with its new strategy regarding its “Android” operating system. Previously only one handset-maker had early access to the Android software. Google will now work with several handset-makers to release the same operating system on multiple devices. This synchronization of uniform software experiences should help the firm in the retail sector.

This attempt to offer the best operating system all at once is also an effort to gain more market share in the tablet space that Apple is dominating. Technology stocks tend to follow one another when they see something working. The dominance in the retail sector by Apple is bound to bring more competitors that will emulate what that firm is doing. Google already is making progress in other parts of the business, as I outlined in the article, Can Google Overcome Potential Pitfalls?

Chart courtesy of www.StockCharts.com

Technology stocks have had a strong move from the lows last fall. Not all technology stocks are alike, of course, so studying the chart of each one gives you a better picture of what the investor sentiment is. Following the wide range from the October low until the peak in early 2012, the stock has been forming a giant wedge. This is a sign that neither the bulls nor bears are in control, but at some point one side will become exhausted and the next leg will begin. One positive sign is that technology stocks and the market overall have sold off quite hard recently, but Google has moved up very strongly. Anytime a stock moves against its market sector, this is quite significant to other technology stocks. The upper bar represents resistance and, if Google can exceed this level, it would be a very positive sign.

I think a lot of positive momentum has been building due to the initial public offering (IPO) of Facebook, Inc. (NASDAQ/FB). Many investors compare technology stocks to each other. When comparing the valuation of technology stocks, investors are looking at Google against Facebook, it’s quite apparent that: a) Google is very cheap; b) Facebook is very expensive; or c) a combination of both. Frankly, at current valuations, Google is far cheaper than Facebook and I think that’s what’s been pushing up the stock.

In a consumer-driven economy, what retailers say about their businesses is very important. For the most part, the retail sector has been saying that business conditions are getting better. A lot of retail stocks performed very well up until the recent stock market correction and valuations are reasonable. I’ve been writing about an underlying strength in the stock market and the U.S. economy and you can see it right now in the retail sector.

The strong first-quarter financial results of Wal-Mart Stores, Inc. (NYSE/WMT) beat consensus and the company expects strong profit growth in the current quarter. A lot of other brand-name companies in the retail sector reported very good numbers for the first quarter and many retail stocks are trading close to record highs on the stock market. Right now, with all the available news and lower oil prices, I’d say that second-quarter earnings season is shaping up to be surprisingly strong.

So, we have a stock market that’s in correction; however, economic news is showing mixed, but generally improving data. Lower oil prices stimulate consumers to spend and they lower the cost of doing business in the industrial sector. While speculators might bet that lower oil prices are a put option on the global economy, the spot price action directly affects the retail sector and that’s good for the economy.

As I keep saying, if we didn’t have the sovereign debt crisis in Europe, I believe the stock market would be a lot higher than it is currently. Corporate earnings growth may not be robust, but it isn’t flat either. The retail sector has been and should continue to be strong through to the end of this year. (See Wall Street Beats Main Street Again.) As well, a lot of industrial companies are expecting a solid bottom half to 2012. And the outlook for the consumer goods sector is also strong, with companies like Colgate-Palmolive Company (NYSE/CL) and Kimberly-Clark Corporation (NYSE/KMB) trading at all-time record price highs on the stock market.

The structural problems in the U.S. economy and the eurozone are almost entirely related to sovereign debt. This is a fundamental problem that needs to be addressed by policymakers. But consumers are doing their part and, as stock market investors, we can see this in the numbers. I fully expect the retail sector to keep outperforming over the coming quarters and the strength in this industry should trickle down to other sectors for a better-than-expected second-quarter earnings season. That’s my current view right now.

The retail sector is a difficult area for many firms to generate strong corporate profits. Corporate profits tend to be at the whim of the fickle consumer. This is true for many firms in the retail sector, except for NIKE, Inc. (NYSE/NKE). NIKE has consistently outperformed many other firms in the retail sector, delivering a 17.5% annual return over the past five years.

Corporate profits for NIKE have continued to grow for several reasons. NIKE’s strategy to grow its presence in the retail sector across many different nations, including the emerging markets, has generated strong growth in corporate profits. Emerging market sales increased 23% from the previous year.

China continues to be a strong market for NIKE in the retail sector, as the company continues to expand. With over 7,000 stores currently in China, NIKE plans to double its revenue over the next several years.

Because the retail sector is so finicky, innovation is the key to driving corporate profits. NIKE is a leader in innovation, which is one reason why corporate profits continue to grow.

Several interesting developments will be drivers for corporate profits later this year. The Olympics, starting in July, will be a nice push in corporate profits for NIKE going into late summer. In the fall, NIKE now has the contract for the NFL. As the exclusive provider for the NFL, NIKE should see a nice bump up in corporate profits near the end of 2012 and first quarter of 2013.

The newest in lightweight shoes, the “Flyknit,” will debut in July at a cost approximately of $150.00. The amazing thing about this shoe is the way it’s produced. This shoe is made by a computer-controlled weaving machine that makes the top portion of the shoe, which is then sewn to the bottom portion. Traditionally, a running shoe would have 37 pieces sewn together, a very labor-intensive procedure that hurts corporate profits. This new process only has two sewn pieces, a definite benefit to corporate profits. The lightweight running category is a huge and growing business for NIKE.

These new lightweight running shoes will weigh approximately half as much traditional running shoes, at 5.6 ounces versus 10.2 ounces. They will be more expensive when sold and less labor-intensive to make, which combines for better corporate profits.

Chart courtesy of www.StockCharts.com

But here’s the question: have investors priced all of these good things into the stock already? The forward price-to-earnings ratio is almost 19, and the price-to-book is over five times. These are very expensive multiples for NIKE. If we look at the stock over the last three years, it has made a tremendous run. While the retail sector has being good to NIKE and corporate profits have grown, this percentage move cannot be sustainable forever.

Technically, the stock is near a key trend level that, if broken, would be a significant warning sign. If that level were to be broken, we could see a pullback initially to the $90.00 range, which should offer some support. If things got even worse, the next level of support could be as low as $75.00, which would also coincide with the 200-day moving average.

While I personally love NIKE’s products and think its innovations have allowed it to be a market leader in the retail sector, the stock price is very high and I certainly wouldn’t be putting money to work right now. A smarter strategy would be to wait until the fall when we’ll get more information regarding the company’s sales of the Flyknit shoe, Olympics clothing and NFL gear. At that point, the stock might have sold off and allowed an even better entry point. Over the next decade, I do see NIKE continuing to be a market leader in the retail sector.